Does Hedging Affect Firm Value? Evidence from the US Airline Industry

Does hedging add value to the firm, and if so, is the source of the added value consistent with hedging theory? We investigate jet fuel hedging behavior of firms in the US airline industry during 1992-2003 to examine whether such hedging is a source of value for these companies. We illustrate that t...

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Bibliographic Details
Published in:Financial management 2006-03, Vol.35 (1), p.53-86
Main Authors: Carter, David A., Rogers, Daniel A., Simkins, Betty J.
Format: Article
Language:English
Subjects:
Air transportation industry
Airline industry
Airlines
Business structures
Business valuation
Capital expenditures
Cash flow
Cash flow forecasting
Costs
Currency
Energy consumption
Finance
Financial investments
Fuel oil prices
Hedging
Hedging (Finance)
Investment risk
Jet fuel
Jet fuel prices
Regression analysis
Risk management
Statistical significance
Studies
Taxable income
Volatility
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Summary:Does hedging add value to the firm, and if so, is the source of the added value consistent with hedging theory? We investigate jet fuel hedging behavior of firms in the US airline industry during 1992-2003 to examine whether such hedging is a source of value for these companies. We illustrate that the investment and financing climate in the airline industry conforms well to the theoretical framework of Froot, Scharfstein, and Stein (1993). In general, airline industry investment opportunities correlate positively with jet fuel costs, while higher fuel costs are consistent with lower cash flow. Given that jet fuel costs are hedgeable, airlines with a desire for expansion may find value in hedging future purchases of jet fuel. Our results show that jet fuel hedging is positively related to airline firm value. The coefficients on the hedging variables in our regression analysis suggest that the "hedging premium" is greater than the 5% documented in Allayannis and Weston (2001), and might be as large as 10%. We find that the positive relation between hedging and value increases in capital investment, and that most of the hedging premium is attributable to the interaction of hedging with investment. This result is consistent with the assertion that the principal benefit of jet fuel hedging by airlines comes from reduction of underinvestment costs.
ISSN:0046-3892
1755-053X
DOI:10.1111/j.1755-053X.2006.tb00131.x