Determinants of extent of financial derivative usage

Abstract

The adaptation of free market policies in the world economy has increased the employment of risk management practices in corporation's financial decisions in order to reduce the variability in firm's future cash flows, due to the highly volatile exchange rates and interest rates. It is generally argued that, extensive usage of derivative instruments can minimize the firm's cash flow unpredictability by reducing financial distress costs, underinvestment problem, tax convexity and managerial ownership. Current paper attempts to identify the factors affecting the corporation's extent of both foreign currency and interest rate derivative instruments by Tobit model using the sample data of 105 non-financial firms listed on Karachi Stock Exchange. Aligned with the Pakistan derivative market, firm's extent of derivative usage is found to be positively related with lower financial distress costs, higher debt, underinvestment problem and fewer managerial holdings.