Analyzing the Impacts of Hedging on Cost of Debt a Case Study in Indonesia’s Public Listed Companies in 2007-2013

Abstract

Nowadays, the use of hedging strategy as part of its risk management strategy is
becoming essential, particularly in Indonesia. This study investigate further the corporate
finance theories which suggest that firms benefit from hedging due to the reduction of
bankruptcy risk or financial distress and the mitigation of agency problem. It studies the impact
of hedging strategy to the cost of debt in a sample of 183 Indonesian companies (1281 year
observations) from 2007 to 2013. Further, this study also examines the sources of hedging
benefit in reducing the cost of debt through the reduction of financial distress and agency costs.
Panel two-stage-least-square (2SLS) and diagnostic tests are conducted to ensure the validity of
the model. It is proven that, throughout the whole process, there is significant negative impact of
hedging to cost of debt. Empirical result shows that hedging firms is paying 141 basis point
lower cost of debt than the non-hedge firms. Additionally, it is proven that hedging is more
beneficial to firm with higher leverage, since the reduction of the financial distress is also
greater. However, this study also gives strong evidence that hedging reduces the cost of debt by
mitigating the agency problem.