Working Paper: CEPR ID: DP15885
Authors: Viral Acharya; Heitor Almeida; Yakov Amihud; Ping Liu
Abstract: We propose that firms face two potential defaults: Financial default on their debt obli- gations and operational default such as a failure to deliver on obligations to customers. Hence, financially constrained firms substitute between saving cash for financial hedg- ing to mitigate financial default risk, and spending on operational hedging, which mitigates operational default risk. Whereas corporate financial hedging increases in leverage, operational hedging declines in leverage. This results in a positive relation- ship between operational spread (markup) and financial leverage or credit risk, which is stronger for financially constrained firms.We present empirical evidence supporting this relationship.
Keywords: financial default; operational default; resilience; liquidity; financial constraints; risk management
JEL Codes: G31; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financially constrained firms (G32) | trade-off between financial and operational hedging (G32) |
| Financial leverage increases (G32) | Operational hedging decreases (G13) |
| Financial leverage increases (G32) | Higher operational spread markup (G19) |
| Credit spread (G19) | Operational spread markup (Y10) |
| Higher short-term debt (H74) | Wider operational spread (L25) |
| Financial constraints (D10) | Sensitivity to changes in credit risk (G21) |