Ingredient hedging and firm value: A study of agricultural commodity price exposures

Abstract: Hedging in all respects, is one of the most fundamental tools when it comes to fulfilling the principal aim of corporate finance – maximizing shareholder value. Also the research about how to calculate the risk and how to hedge against it has been meticulously assessed in famous research papers that cover almost every detail of risk management. Nonetheless, the missing part in the risk management field seem to be a more practically-oriented and general framework that answers more specific and narrow questions when it comes to such as what types of risks one should hedge and how much of that risk one should hedge. This paper assesses the production input price exposure of corporations that use agricultural commodities as inputs in production, something that have yet not been done in previous research. The analysis is performed by comparing the linear relationship between fluctuations in a stock price with fluctuations in the commodity price, for companies that practice commodity hedging and companies that do not. In order to affirm whether or not commodity hedging has a value enhancing effect on equity in addition of having a value-stabilizing effect we use Tobin’s q-statistic as a proxy for firm value and study how it is affected by hedging. In addition, we try to explain why hedging enhances the value by analyzing how hedging affect the internally generated cash flow that can be used for value-creating activities such as investing in profitable projects. Our findings indicate that hedging companies are more valuable because their internally generated cash flows are higher. Our recommendations for companies exposed to price fluctuations in agricultural commodities are thus to hedge.