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MRN
31,8

An examination of US dollar risk

management by Canadian
non-financial firms
Alex Faseruk

570

Faculty of Business Administration, Memorial University of Newfoundland,

St Johns, Newfoundland and Labrador, Canada, and

Dev R. Mishra
Edward School of Business, University of Saskatchewan,
Saskatoon, Canada
Abstract
Purpose The purpose of this paper is to examine the impact of US dollar exchange rate risk on the
value of Canadian non-financial firms.
Design/methodology/approach The sample, from the Compustat database, includes all nonfinancial Canadian firms with sales over $100 million. The study segregates firms into hedging and
non-hedging groups and applies statistical techniques to test if hedging enhances value.
Findings The results demonstrate that Canadian firms that have higher levels of US$ sales tend to
use derivatives more frequently through higher levels of US$ exposure. Firms that have both US
sales and assets appear less likely to use hedging. Firms with an American subsidiary and use
financial instruments to hedge have higher values. When operational hedging is used with financial
hedging, it is a value enhancing activity increasing their market-to-book by 14 per cent and market
value-to-sales by 40 per cent. Incremental impact of these two hedging strategies is to enhance value
by 7 per cent.
Research limitations/implications The sample from Compustat captures large capitalization
Canadian firms but ignores about 75 per cent of Canadian firms. There is a bias towards larger firms.
Some hedging items are not disclosed on financial statements. A survey would enhance and
complement these results.
Practical implications The paper finds that it is important for Canadian firms that have exports
denominated in US dollars to hedge their exposure. The full value of hedging is reaped by using both
operational and financial hedges.
Originality/value This study is the first that examines US dollar risk management by Canadian
firms.
Keywords Hedging, Financial risk, Currency options, Canada, United States of America,
Exchange rates
Paper type Research paper

1. Introduction
In this study, the value implications of financial and operational hedging of United
States (US) dollar exposure by Canadian non-financial firms are examined. The
financial hedging of US dollar risk refers to the use of financial instruments to reduce
foreign exchange exposure by Canadian firms through various means, such as US
dollar derivative contracts. Operational hedging refers to a Canadian firm possessing
American denominated assets, operations or subsidiaries doing business in the USA.
Management Research News
Vol. 31 No. 8, 2008
pp. 570-582
# Emerald Group Publishing Limited
0140-9174
DOI 10.1108/01409170810892136

The authors are grateful to the discussant and seminar participants at ASAC 2005, EFA
2006, especially discussant Gautam Goswami at EFA 2006, and seminar participants at FMA
2006, especially David Carter for helpful comments.

In an efficient capital market, or under the restrictive assumptions of Modigliani

and Miller, hedging by itself would not be expected to enhance the value of the firm.
However, when one considers various market frictions, endemic to the financial
environment, the inclination is to develop models designed to capture the effect of
hedging on financial performance in order to justify the usage of hedging strategies.
Financial hedging is viewed as value-maximizing by management if combined with
operational hedging (Allayannis et al., 2001). An operational hedge is also viewed as a
significant means to reduce foreign exchange rate risk (Pantzalis et al., 2001). Firms
should take into account not only the breadth, but also the depth dimensions of a multinational corporations (MNC) foreign subsidiaries. It is important to examine the
impact of operational hedges on exposure separately that can influence value in MNCs
either negatively or positively.
A more basic question is whether firms are indeed exposed to foreign exchange risk.
During the past decade, several attempts were undertaken to measure the extent of the
exposure ( Jorion, 1990; Bodnar and Gentry, 1993; Bartov and Bodnar, 1994; Chow et al.,
1997). These studies have documented only a weak relationship between share
performance and exchange rate fluctuations. Notwithstanding the weakness of these
results, case studies (Pringle, 1991), survey results (Bodnar et al., 1998), as well as
anecdotal evidence from financial practitioners, all contend that foreign exchange
exposure is an important consideration for most firms and MNCs in particular. Thus,
many corporations actively undertake hedging techniques designed to lessen foreign
exchange exposure, despite the paucity of evidence documenting a strong relationship
to its performance in the financial markets. Some have questioned whether or not
hedging through derivatives reduces foreign exchange risk while other studies have
found that firms which employ foreign exchange risk management have recorded
higher values (Allayannis and Weston, 2001; Copeland and Copeland, 1999; Copeland
and Joshi, 1996).
While the existing literature in foreign exchange risk management by non-financial
firms is diverse, comparatively few studies explore this issue in relation to Canadian
non-financial firms. Jalilvand (1999) used corporate hedging explanations to examine
observed differences in the use of derivatives by Canadian non-financial firms. His
study demonstrated that the scale, operational efficiency and level of integration of
treasury activities are important determinants for identifying Canadian and
international users of derivatives. The current study examines the US dollar risk
management practices of Canadian firms. Specifically, the issue of whether CA$/US$
risk management by Canadian firms is both risk reducing and value enhancing is
examined.
Most studies focus on the foreign exchange risk management using a sample of US
firms. The larger American sample provides the most robust test of firm value
implications of hedging. There are specific advantages in studying foreign exchange
risk management of Canadian firms. The primary advantage is that US foreign trade is
highly diversified around the globe, while that of Canadian is highly concentrated with
the USA. For example, the highest US export/import to a single country is about 23
per cent, whereas Canadas average exports to the US are about 85 per cent and imports
are about 60 per cent[1]. This uniquely concentrated Canadian foreign trade allows for
generation of a substantially large sample of firms with transaction exposure to only
one currency the US dollar. Therefore, the sample provides a unique test of the effect
of foreign exchange risk management as the firms in this study have exposure to a
single foreign currency.

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management

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The results of the current study demonstrate that Canadian firms with higher levels
of US sales tend to use derivatives more frequently and encounter higher levels of US$
exposure. However, firms that have higher levels of both US$ sales and assets appear
less likely to use financial hedging. Arguably, US assets held in conjunction with sales
provide a natural operational hedge for these US sales made by Canadian firms. Firms
that have a US subsidiary and use financial instruments to hedge US dollar risk have
higher values than other firms in this sample. Overall, this paper finds that the
Canadian non-financial firms that use operational hedging in conjunction with
financial hedging of US dollar risk have higher relative values on average. For
example, such firms have higher market-to-book ratios by about 14 per cent with the
market value-to-sales ratios being over 40 per cent higher.
This remainder of the paper is divided into four sections. Section 2 reviews the
relevant literature. Section 3 describes the data. Section 4 presents the methodology,
analysis and results. The paper is concluded in section 5.
2. Literature review
Many firms have transactions and assets denominated in a currency other than their
own domestic currency. This fact provides a source of risk for that firm. Recent studies
have examined foreign exchange risk management (Bodnar et al., 1998; Dolde and
Mishra, 2007; Geczy et al., 1997; Jorion, 1991). Some studies relate hedging to firm value
(Allayainnis and Weston, 2001). Recent studies have also combined operational and
financial hedging together into a single risk management paradigm (Allayannis et al.,
2001). Few studies involving Canadian firms exist, with some notable exceptions
(Jalilvand, 1999; Booth and Rotenberg, 1990).
Early literature found evidence that the exchange rate exposure does not matter in
integrated or efficient markets ( Jorion, 1990; 1991). In recent years, exchange rate risk
and exposure was found to be significant and a matter for concern for US corporations
(Allayannis and Ihrig, 2001; Chow et al., 1997; Dominguez and Tesar, 2001; Griffin and
Stulz, 2001). Foreign exchange risk was the most widely hedged risk using derivatives
(Bodnar et al., 1998). The impact change in exposure was found to vary in changing
value from very small fractions (Allayannis and Ihrig, 2001) to a significant exchange
rate exposure across countries at firm and industry levels (Dominguez and Tesar,
2001). The current study documents that exchange rate exposure matters even across
integrated financial markets, such as Canada and the USA.
Other studies found that foreign exchange exposure related to both operational and
financial hedging (Allayannis et al., 2001). Results have also shown that operational
hedging is value maximizing if it is combined with financial hedging, and that the
hedging successfully reduced foreign exchange exposure. Accordingly, exposure was
related to the use of operational hedging (Pantzalis et al., 2001). It was also found that
firms with greater operations network breadth exhibited less exchange rate risk, while
firms in highly concentrated networks were more exposed to such risk (Pantzalis et al.,
2001).
Canadian firms may be in greater need of foreign exchange risk management,
particularly with respect to the US dollar. The large majority of Canadian trade is
conducted in US dollars either through direct trade with the USA or by dealing in
international trade wherein the trade is denominated in American dollars. The
Canadian economy is not only export-driven, but also deals in many raw materials
where the unit of account is American currency, such as oil, precious and base metals,
and lumber. Accordingly, the rate of exposure by Canadian non-financial firms is very

high. The US dollar exchange rate is arguably the single most important foreign factor
affecting the Canadian economy in short-term transaction and long-term economic
exposure. Exporting and importing firms follow the appreciation and depreciation of
the US dollar very closely as often their level of profitability and their share price are
directly tied to movements in that currency.
Thus, the primary hypothesis for this study is that the hedging (operational and
financial) of US dollar exchange rate risk would be a value maximizing activity by
Canadian non-financial firms.
3. Data description
The data sample initially included all Canadian non-financial firms with sales
exceeding $100 million in 2001 represented in Compustats Canadian stock file[2]. This
search from Compustat returned a total of 447 firms. The firms cross-listed in the US
exchanges are required to file their annual reports to the Securities and Exchange
Commission (SEC) according to American general accepted accounting principles
(GAAP), as well as SEC requirements. Therefore, the amount of foreign sales and assets
reported may already be fully in US dollars, thereby accounting for transactions and
translations risk. In addition, the pricing of the stocks on the American Stock
Exchanges, notably the New York Stock Exchange and National Association of Security
Deeler Automatic Quotations (NASDAQ), may already have incorporated the exchange
rate effect of US sales/assets in a different fashion than the stocks that traded solely on
Canadian exchanges. For example, the Potash corporation (primarily a Saskatchewan
corporation) normally declares and pays its dividends in US dollars, but the corporation
encounters sales in both Canadian and America dollars. However, the different amounts
of sales and location of the shareholders are not disclosed. Accordingly, one does not
know the extent to which hedging of the dividend payment has already taken place,
perhaps through a natural hedge. Therefore, all cross-listed firms between Canadian
and American Stock Exchanges are excluded, leaving 303 firms that are listed only on
Canadian Stock Exchanges. Often it is not clear in cross-listed firms as to what is being
hedged. Canadian firms that are cross-listed on American exchanges often have a
substantial part of the business operations in the USA. For example, Nortel Networks
volume of business on both sides of the border, it is hard to distinguish whether it is
optimal form the firm to manage risk from the perspective of US dollar investors or
Canadian dollar investors. Similarly, Potash corporation a Saskatchewan-based mining
company pays its dividends in US dollars. Hence, it is difficult to determine whether
these cross-listed firms are maximizing the value of US dollar or Canadian dollar
investors. Therefore, cross-listed firms are excluded from the sample.
For the remaining 303 firms, a manual search of annual report footnotes available
from www.sedar.com was conducted for information on use of foreign exchange
derivatives, e.g. futures, forwards, options and swaps, or at least a statement about
some instruments that reflected hedging of US dollar exchange risk in 2000 and 2001.
From the hedging data, the existence of US and non-US subsidiaries, the amount
foreign dollar denominated sales and foreign assets were extracted. Excluded were all
stocks that contained ambiguous information on the currency hedged, as the intent of
this study was to examine US$ hedging by Canadian non-financial corporations. In
addition, some firms whose names could not be clearly matched in sedar were
excluded. For the firms remaining in the sample, the price-to-book ratio, market value,
total debt, total assets and total sales data were all extracted from Compustat. The
firms that did not have complete data on all the selected variables for these years were

US dollar risk
management

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MRN
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574

also excluded. The final sample included 316 useable observations involving 194
Canadian firms over 2000 and 2001. Three of these firms traded on the Canadian
Venture Exchange with the rest from Canadas major exchange, the Toronto Stock
Exchange.
4. Analyses and discussion
4.1 Proxies of value, hedging and exposure
Four proxies of value were created: first, closing stock price per share divided by book
value per share (PriceBook), as available in Compustat annual files; second, total
capital divided by total assets (TCTA), where total capital refers to the total of longterm debt, preferred stock and market value of equity. The third proxy is total market
value of equity divided by sales (PriceSales) with the fourth being total capital divided
by sales (TCSales).
The proxy of US dollar hedging is created under two types of observations in the
annual reports. The first proxy of hedging is a binary variable. Firms are classified as
HEDGERS, if annual report footnotes contained at least one statement that the firm
hedged US$ risk, or a statement that the firm used US$ derivatives or reported explicit
amount for US$ denominated derivatives (options, futures, swaps, forwards or US$
denominated loan). HEDGERS are assigned a value of 1. The firms that do not
qualify as HEDGERS are denoted as NON-HEDGERS and are assigned a value of 0.
There are total of 130 firm/years of data for HEDGERS and 186 firm/years for
NON-HEDGERS.
The second proxy of hedging is based on the explicit amounts of US$ hedging
instruments available in the annual report footnotes. The firms that have explicit
amount for one or more hedging instruments (options, futures, swaps, forwards or
dollar denominated loan) in US$ are classified as E-HEDGERS, and the firms that do
not qualify as E-HEDGERS are classified as E-NON-HEDGERS. There are 102 firm/
years of data for E-HEDGERS and 214 firm/years of data for E-NON-HEDGERS.
The proxy of foreign exchange exposure is created using the two-factor market
model as previously done in Jorion (1990, 1991). See equation (1). In this equation, Rit is
the time series of stock returns; Rmit is the time series of contemporaneous market
returns,
(ExchangeRate)it is the time series of change in the CA$/US$ exchange rate.
The symbol i is the coefficient of exchange rate exposure and uit is the error term. An
exposure for 2000 is measured by using time series of monthly data from June 1998 to
May 2001. For 2001, it is measured using data from June 1999 to May 2002, similar to
the approach used in Allayannis et al. (2001). The paper records the absolute value of i
as exposure. Note that some firms have a negative value for i. A firm with a negative
i cannot be regarded as being an exposure less than that of a firm with zero exposure.
Therefore, the absolute value of the coefficient is employed instead of the actual
value[3].
Rit i i Rmit i
ExchangeRateit uit

4.2 Descriptive analysis

Table I provides the cross-sectional descriptive statistics of the sample. The sample is
divided into four categories, based both on hedging tendencies and control variables.
Panel 1 of Table I shows the value impact of hedging for the Canadian firms with a US
subsidiary vs without a US subsidiary.

Hedger
Panel 1: US subsidiary
No
Yes
Both
Yes-no
TSTAT (Yes-no)
Panel 2: US sales
No
Yes
Both
Yes-no
TSTAT (Yes-no)
Panel 3: US assets
No
Yes
Both
Yes-no
TSTAT (Yes-no)
Panel 4: US sales and assets
No
Yes
Both
Yes-no
TSTAT (Yes-no)
Panel 5: E-hedger _US subsidiary
No
Yes
Both
Yes-no
TSTAT (Yes-no)

No

Average price-to-book value ratio

Yes
Yes-no
T-statistics

ALL

1.85
1.44
1.72
0.42
1.16

1.66
2.15
1.90
0.50***
1.83

0.20
0.72*
0.18

0.55
2.65
0.69

1.99
1.64
1.88
0.34
0.91

1.51
2.03
1.77
0.53**
1.97

0.48
0.39
0.11

1.32
1.37
0.42

1.84
1.59
1.75
0.26
0.82

1.63
2.22
1.91
0.59***
1.81

0.21
0.64**
0.16

0.60
2.21
0.67

1.84
1.66
1.78
0.18
0.57

1.63
2.16
1.88
0.53
1.60

0.21
0.50***
0.10

0.60
1.69
0.42

1.76
1.90
1.82
0.14
0.58

1.95
1.09
1.72
0.86
2.62

1.68
2.27
1.90
0.59
2.03

0.27
1.18*
0.18

0.79
4.23
0.69

1.82
1.82
1.82
0.00
0.01

US dollar risk
management

575

Notes: Hedgers include the firms that have an explicit indication in the annual report that the
firm managed US dollar risk, while E-Hedgers refers to the firms reporting explicit amount
foreign exchange derivatives use in the financial footnotes; *significant at 0.01 level; **significant
at 0.05 level; ***significant at 0.01 level

From the table, it is observed that HEDGERS are more highly valued by the market
than NON-HEDGERS, as all four value-measures clearly demonstrate that HEDGERS
with a US subsidiary are the most valuable firms, while the HEDGERS without a US
subsidiary are the least valuable firms. In line with Allayannis et al. (2001), one may
make following interpretation of this result. Assuming the existence of a US subsidiary
as operational hedging and the use of US$ derivatives as financial hedging, the use of
both operational and financial hedging is value enhancing while the use of only one is
not. For example, the average for the value proxies for HEDGERS with US subsidiary
is the highest; that for the NON-HEDGERS with no US subsidiary is the second
highest, followed by other two sub-categories. This result may also imply that the
market penalizes Canadian firms that use financial hedging and do not have a US
subsidiary. Moreover, HEDGERS with at least one US subsidiary have a 14 to 54
per cent larger average for value proxies than an average firm, and about 28 to 97

Table I.
Descriptive statistics of
value impact of hedging
grouped by the firms
with their characteristics
on US exposure through
an operation, sales and
assets

MRN
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576

per cent larger than that of HEDGERS with no US subsidiary. Results in Panel 5 of
Table I, which measures firms hedging tendency as E-HEDGERS and E-NONHEDGERS, are consistent with those of Panel 1.
Panel 2 of Table I groups firms on US sales volume available in annual reports, i.e.
firms reporting an amount for US sales vs firms not reporting an amount for US sales.
As the table indicates, firms with US sales have higher average price-to-book values
than those without US sales. The existence of US Sales is equivalent to having
transaction exposure in a Canadian firm to the US dollar. Results in this table show
that the HEDGERS with US sales have the highest values, whereas NON-HEDGERS
with US sales have the lowest values implying that the market penalizes firms that do
not hedge the US dollar risk associated with US sales.
Note the difference between Panel 1 and Panel 3, that the market penalizes two
groups of firms, which are HEDGERS with no US subsidiary, and NON-HEDGERS
with US Sales. As expected NON-HEDGERS without US sales have higher values than
the HEDGERS without US sales. Overall, the results in this table imply that it is
important for Canadian firms to hedge transaction exposure related to US sales. All
exporting Canadian firms are markedly better off hedging their US dollar risk.
Moreover, transaction exposure may also be related to imports. However, as the import
data are not available, no inferences could be made about total transaction exposure.
This area can prove fruitful for further research.
Panel 3 of Table I divides firms based on explicit amounts of US assets available in
annual reports, i.e. firms reporting an amount of US assets vs firms not reporting an
amount of US assets. In line with Allayannis et al., (2001), the existence of US assets,
such as the existence of a US subsidiary, can be regarded as being equivalent to
operational hedging. Consistent with the operational hedging argument, the results in
this table show that the HEDGERS that have US assets exhibit the highest average
values, while NON-HEDGERS without an explicit amount of US assets have the lowest
average values[4].
Panel 4 of Table I divides firms that have reported both US sales and US assets and
that have not reported one of the two or both. Consistent with all other tables,
HEDGERS reporting both US sales and US assets demonstrate the highest average
values. Overall, the results in Table I Panels 1 to 5 indicate that operational hedging
(having subsidiary or assets) is beneficial to manage foreign exchange risk only if
backed by financial hedging. Similarly, the use of financial hedging by exporting firms
is value maximizing, while by non-exporting firms is value deteriorating. The
following section further explores these findings further through the use of
multivariate statistical analysis.
4.3 Regression tests
Table II provides regression results of foreign exchange exposure measured using an
equation utilizing the aforementioned different hedging measures and varying
amounts of foreign sales. The first two rows present regression of exposure with the
percentage of the firms sales denominated in US dollars (US_SALES), a dummy
variable for financial hedging of US dollar risk (US$_HED) with 1 for HEDGERS and
0 for NON-HEDGERS, and a second dummy variable for the presence of at least one
US subsidiary (US_SUB) with a 1 for the firms with US subsidiaries, 0 otherwise.
The US dollar exposure of Canadian firms is positively related to the proportion of US
sales. This result is consistent with the literature that foreign exchange exposure is a
positive function of foreign sales (Allayannis et al., 2001). Further, the coefficient of

i a a1USSales a2USAssets a3USHed a4US_SUB USHed*Derivatives e

US_SALES

1.000**
2.245

US_HED
US_SUB
USHED*US_SALES
constant
2

Adj R
Sample size

0.535
0.846

0.240
1.133
0.261
0.972

0.023*
7.836
0.251
1.168
0.057
0.263

1.715*
8.942
0.008
288

1.778*
9.355
0.004
288

US_ASSETS

US dollar risk
management

0.452***
1.769
0.221
0.800
0.902
1.787*
8.692
0.009
288

Notes: Dependent variable is the coefficient of foreign exchange exposure based on P. Jorions 2
factor model (in Canadian dollars) US hedging is a dummy and US sub is also dummy, however,
sales and assets ratio are actual figures. T-statistics are based on robust SEs; *significant at 0.01
level; **significant at 0.05 level; ***significant at 0.01 level

US$_HED and US_SUB is negative which should indicate that both financial and
operational hedging reduce foreign exchange exposure. However, these coefficients are
not significant and do not affect value. This result is inconsistent with the findings in
the past literature with foreign exchange exposure of US firms[5].
The second set of the next two rows in Table II drop US_SALES from the
regression, replacing it instead with the proportion of US assets (US_ASSETS).
Interestingly, the coefficient of US_ASSETS is both negative and significant. This
result implies that the proportion of US assets substantially reduces US dollar risk
exposure incurred by Canadian firms. The sign and significance of the coefficient of
US$_HED remain unchanged. One may interpret these results as the existence of
explicit assets in the US provides significant operational hedging of US dollar exposure
of Canadian firms, rather than simply having an America subsidiary.
The important question now becomes, What type of Canadian firms hedge US
dollar risk? Table III provides results to this question through the probit test of
financial hedging dummy vs US_SALES, US_ASSETS and US_SUB along with
interaction variables and the associated tobit test. The first two rows show that the
firms with higher proportions of US sales hedge more often. While hedging tendency is
negative, it is also insignificant when examining the proportion of firms assets in the
US (US_ASSETS). Consistent with Table II, foreign assets provide some sort of
hedging of foreign exchange exposure resulting in the reduced need for financial
hedging. However, as seen in the next two rows, after adding an interaction variable for
both US_SALES and US_ASSETS, the coefficient for US assets is positive and
significant at the 0.10 level. Further, the coefficient for interaction variable is negative
and significant at 0.05 level implying that the firms that have both US dollar sales and
US assets tend to indulge to a lesser extent in the hedging of US dollar foreign
exchange risk. The next two sets of regressions show that the existence of a US
subsidiary does not necessarily alleviate the need for financial hedging. However, when
examining firms that have both US subsidiary and sales, the relationship is significant
at the 0.10 level.

577

Table II.
US dollar exposure
and hedging

Table III.
Probit and tobit analysis
of US dollar hedging

0.338*
3.644
1.60%
316

0.712*
7.598
7.47%
316

1.342*
4.480
0.134
0.086

0.36*
3.852
3.30%
316

1.946
0.800*
6.784
5.27%
316
0.724*
6.594
2.42%
316

1.769
0.557*
4.747
4.30%
316

0.175
0.904

1.783*
3.055

8. Derivatives

1.297*
0.739*
7.609
7.82%
316

0.021
0.125

0.789*
2.752

7. Derivatives

1.341***

1.116

0.489*
4.439
3.30%
316

1.256*
4.339
1.755*
3.073

6. Derivatives

2.245

0.606*
3.091

1.167***
1.725

5. Derivatives

2.805

0.435*
2.548

0.107
0.353

4. Dummy

2.646**

0.998*
2.973
0.252***
1.837

3. Dummy

Notes: Probit test of the relationship between the US$ derivatives use and US$ sales, assets and operations. Dependent variable is US financial hedging
Dummy for Models 1 to 4 and reported value of us $ derivatives as percentage of sales. Hedging  1US Sales 2US Assets 3US_SUB
Dummy 4US Sales*US Assets 6US_SUB*US Sales "; *significant at 0.01 level; **significant at 0.05 level; ***significant at 0.01 level

Chow R2/Correlation2
Sample size

Constant

US_SUB*
US_SALES

US_SALES*
US_ASSETS

US_SUB

US_ASSETS

0.53**
2.056
0.046
0.783

2. Dummy

578

US_SALES

1. Dummy

MRN
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Table IV provides regression tests of different measures of value with different

measures of hedging and control variables. In this table, the coefficient of interaction
variables provides very cogent argumentation. Table IV has been produced using the
price-to-book ratio as the main proxy of firm value. In these regressions, correction is
also made within the SE for heteroskedasticity with the interaction variable
USHed*US_sales used in selected specifications. Further, as discussed subsequently,
this variable USHed*US_Sales is notable not only in Table IV but also in Table II. As
well in Table IV the quantitative proxy of hedging, USHed*Derivatives is also
included. Derivatives represent the notional value of hedging instruments used by the
firms divided through by the firms sales in order to provide the appropriate
percentage of sales hedged. Consistent with Allayannis et al. (2001), operational
hedging when combined with financial hedging is significantly value enhancing. The
coefficient of 0.07 for the interaction variable US$_HED*US_SUB implies that even
after controlling for firm size, the incremental value impact of using both operational
and financial hedging strategies by Canadian firms is about 7 per cent.

US dollar risk
management

579

5. Conclusion
This study analyzed the impact of US dollar exchange rate risk management by
Canadian non-financial firms traded exclusively in Canadian markets and that have a
sales of $100 million and higher in 2001. Data on financial and operational hedging
were hand collected from financial footnotes from 2001 annual reports of the sample
firms, which provided hedging, foreign sales and asset information for 2000 and 2001.
As expected, Canadian firms that have higher levels of US sales tend to use
derivatives more often and tend to have higher levels of US$ exposure. However, firms
Models
US_HED

0.09
0.92

0.06
0.53

0.567*
2.87
0.08
0.74
0.320**
2.34

0.519**
2.32
0.03
0.31

0.492**
2.11
0.02
0.24

0.09
0.80
0.377**
2.07

0.05
0.59

0.04
0.45

0.02
0.51

0.11
0.45
0.02
0.58

0.02
0.47

0.01
0.18

0.31
1.39
0.03
0.81

0.12
0.50
0.7%
316

0.11
0.46
0.8%
316

0.19
0.82
2.1%
316

0.25
1.04
2.8%
316

0.10
0.43
1.4%
316

US_HED*US_SUB
US_HED*US_SALES
LnSales

0.13
0.97

US_HED*Derivatives
US_SUB

GEXP1
Constant
R2
Sample size

0.431***
1.83
0.04
1.06
0.03
1.27
0.08
0.32
2.7%
288

Notes: Regression of firm value with different measures of US financial and operational hedging.
The T-statistics is based on robust SEs. Firm Value  1US_HEDit 2US_HEDit*Derivatives
3US_SUBit 4US_HEDit*US_SUBit 5US_HED*US_Salesit 7LnSalesit 8Exposureit ";
*significant at 0.01 level; **significant at 0.05 level; ***significant at 0.01 level

Table IV.
Firm value and hedging

MRN
31,8

580

with both US sales and US assets tend not to use financial hedging as often. The US
assets provide some sort of natural operational hedging for US sales of Canadian firms.
Firms that have at least one US subsidiary (or reported assets) and that use financial
instruments to hedge US$ risk tend to have higher values than other firms. Hence, the
use of operational hedging in conjunction with financial hedging of US$ risk by
Canadian firms is value enhancing; this result is consistent with existing literature that
has studied American firms. On average, the market-to-book ratio of such firms is 14
per cent larger and market value-to-sales ratio is over 40 per cent than those of an
average firm. The incremental value impact of using both financial and operational
hedging together is about 7 per cent.
The paper has two major contributions. First, this is the first study that examines
the US dollar risk management by Canadian firms. Second, it documents that it is
important to hedge US dollar risk for the firms that have US exports. Firms are better
off by implementing both operational and financial hedging of US dollar risk.
The study is not free of limitations. First, the sample is drawn from the population
of firms represented in Compustat, which excludes almost 75 per cent of Canadian
firms, which represents a significant proportion of market capitalization. Second, the
information disclosed through annual reports may not be fully complete; hence, a
survey may provide richer information on derivatives use by Canadian firms which
future studies may consider pursuing.
Notes
1. Estimates are based on the Canadian export and import data from Statistics Canada for
the years 2001 to 2005.
2. Sales in 2000 were obviously different from sales in 2001. The lowest sales in 2000 were
$45 million, and in 2001 were $100.3million. $ refers to Canadian dollar unless otherwise
stated as US$.
3. There is a debate in literature regarding the appropriate model for the measurement of
foreign exchange exposure. One school of thought, led by Adler and Dumas (1984),
argues the use of a single-factor model for measuring exposure, while another school of
though led by Jorion (1990) argues for the two-factor model. This paper does not involve
itself in this debate but uses the two-factor model as it is used in most of the recent
literature, such as Allayannis et al. (2001) and Bodnar and Wong, (2003), among others.
4. One may note that the firms explicitly disclosing an amount for US assets are less than
the firms that reported a US subsidiary. Although, this information may be somewhat
contradictory, however, it is as found in annual reports without further examining this
anomaly except to say that this situation may be partially explained by a nature hedge
given that a gain in asset value may offset the transactional loss and vice versa for the
opposite situation.
5. For example, see Allayannis et al. (2001), Allayannis and Weston (2001).
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Board of Governors of the Federal Reserve System, International Finance Discussion
Papers # 709.

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About the authors

Alex Faseruk graduated from Queens University, Dalhousie University and the University of
Kentucky (DBA). He has been a professor at Memorial University since 1981 and is the Associate
Dean (Research). Dr Faseruk has received 21 teaching awards including his Presidents Award
for Distinguished Teaching. Externally, he received the Leaders in Management Education
Award from the National Post, a 3M Teaching Fellowship and has been recognized by Beta
Gamma Sigma and the Academy of Finance. His research has appeared in Journal of Business
Venturing, Journal of Applied Business Research, Finance India, Canadian Treasurer,
Management Research News and Journal of Financial Management and Analysis. Alex Faseruk
is the corresponding author and can be contacted at: afaseruk@mun.ca
Dev R. Mishra is an Associate Professor of Finance at the Edwards School of Business,
University of Saskatchewan. Professor Mishras research interests are in the area of Corporate
Finance, International Corporate Finance with emphasis in Corporate Governance, Cost of
Capital, Foreign Exchange, International corporate diversification, emerging markets, and Share
Repurchases. He has published papers in the journals like Financial Management, Financial
Review, Emerging Markets Finance, and Quarterly Journal of Business and Economics. He
teaches International Corporate Finance and Corporate Finance courses at the University of
Saskatchewan.

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