Corporate derivatives use and firm value: conditional role of corporate governance

Abstract

Purpose

This study aims to examine the effect of corporate derivatives use on firm value and how the corporate governance index modifies this relationship.

Design/methodology/approach

The sample consists of 219 nonfinancial firms on the Pakistan Stock Exchange (PSX) from 2011 to 2019. The study used ordinary least square regression with year and industry dummies for estimations. Multiple estimation models such as fixed/random effect, Fama–MacBeth and two-stage least squares (2SLS) are used for robustness. Finally, the PROCESS macro tool is used to estimate the effect of moderating the role of corporate governance (CG) as robustness.

Findings

The findings show that derivatives use has an inverse influence on firm value. The firms did not use derivatives as a risk management tool but for speculation motives. However, the corporate governance index significantly weakens this relationship. However, strong governance forces the managers to use derivatives for hedging purposes. The firm-specific factors, including size, age, leverage, cash, financial distress cost, dividend and growth opportunities, also significantly influence firm value. The findings are robust to the other estimation models.

Research limitations/implications

The findings indicate that emerging economies like Pakistan are more prone to agency problems. The strong corporate governance structure helps firms turn the speculative motive of derivatives use into hedging purposes and mitigate the agency issues.

Practical implications

This empirical evidence suggests that good governance structures can help improve the impact of derivative usage on firm value.

Originality/value

To the best of the author's knowledge, this is the first study that examines the conditional role of corporate governance on the derivatives–value relationship from the viewpoint of agency problem/speculative motive.

Citation

Butt, A.A., Rizavi, S.S., Nazir, M.S. and Shahzad, A. (2022), "Corporate derivatives use and firm value: conditional role of corporate governance", South Asian Journal of Business Studies, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/SAJBS-02-2021-0059