How corporate derivatives use impact firm performance?

It is an empirical question over whether the use of derivatives hedging among firms is actually effective in mitigating financial risks, and hence positively contributes to firm performance. This study uses three performance models (firm market value, ROA and ROE) and a two-stage regression to simultaneously estimate the performance and derivatives use models, to address any possible endogeneity problem. It provides empirical evidence, which is rare in Malaysia and developing markets, of the effectiveness of using derivatives for hedging among firms. Specifically, this study finds that capital market imposed a ‘discount’ on derivatives users – derivative use is negatively associated with firm market value. However, derivative use contributes to better ROA (and ROE), a key driver of firm market value. Firms with lower operating income margin tend to use derivatives to protect this already thin margin from the potential financial risks. Finally, derivatives users are, overall, better at generating sales from assets than non-users because derivatives use allow them to manage the associated incremental financial risks better.