Description
Abstract: Properly implemented risk management practices can help maximize shareholder value by reducing the expected cost of financial distress, and as such firms in deeper financial distress are expected to hedge more. However, empirical studies on such relationship have yielded mixed results. This paper documents the main determinant of hedging decisions using a newly assembled dataset for 92 Canadian-based, publicly traded oil extraction companies between 2005 and 2015. We adopt empirical techniques - Honoré's semiparametric model and simultaneous equations with the minimum distance estimator - that explicitly deal with issues that frequently arise when studying hedging decisions, namely a clustering of firms that choose to not hedge at all and the endogeneity associated with concurrent determination of hedging and borrowing decisions. Even after controlling for endogeneity and other possible drivers of hedging, we still detect a positive and statistically significant relationship between a firm's perceived financial distress and the degree to which it hedges.