DERIVATIVES

Uses and Misuses of Derivatives

About the authors

Chris Mallin

Chris Mallin is Professor of Finance and Director of the Centre for Corporate Governance Research at the University of Birmingham, UK. She has published widely on corporate governance issues and is a member of several international committees on corporate governance. She is also the Editor of 'Corporate Governance: An International Review'.

Responsibilities

Director Centre for Corporate Governance Research

Director MSc Corporate Governance and Corporate Responsibility

Shareholder Voting Work Group (chaired by Paul Myners)

International Corporate Governance Network

Kean Ow Yong

Kean Ow Yong is a lecturer of Finance and Director of the Centre for Corporate Governance Research at the University of Birmingham, UK.

Research Interests

Corporate Governance, Risk Management and Financial Markets

Responsibilities

Programme Director, MSc Investments

Martin Reynolds

Martin covers business and technology issues related to computing hardware. He is particularly interested in the progress of computing capabilities, and how technology may be applied to business advantage.

Research interests

UKZN-LC: University of KwaZulu-Natal Leadership Centre (UKZN-LC) research collaboration with OU-OSRG (open systems research group) on local governance, social learning and systems support.

ECOSENSUS: electronic, ecological collaborative sense-making support system. Collaborative study involving environmental scientists and impoverished natural resource users in Guyana, and colleagues in the UK including OSRG Visiting Professor, Werner Ulrich appointment).

SLIM: social learning for the integrated management and sustainable use of water at catchment scale. EU funded project co-ordinated by the OU Systems Department, finished in 2004. Recommended set of policy briefs available from hyperlinked website.

Abstract

In this paper, the authors present the results of a 1997 survey of derivative used by some 231 UK non-financial companies. The questionnaire instrument used in this research is based upon the postal survey methodology of Bodnar et al. (1995). A glossary was attached to the questionnaire survey to enable consistency in defining terminology used. A direct comparison between US and UK findings was undertaken together with an analysis of results from other published surveys conducted in the last four years. We find broadly similar trends in the use of derivatives. The results of our research show that derivatives usage to hedge financial price risk is well established amongst larger UK companies. Our findings support the size effect phenomena reported in other empirical studies.

The primary objective cited in using derivatives was to manage fluctuations in accounting earnings, a focus that is inconsistent with the theoretical view of paying attention to cash flow benefits of hedging. The predominant issues of concern to UK financial directors are the lack of evaluation of risk of proposed derivative transactions and the level of transaction costs incurred. This contrasts with the greater concerns of credit risk and market risk raised by their US counterparts in Bodnar's study. A possible explanation for these concerns could be the impact of the currency crisis happening in Asia especially for firms that are exposed to the affected currencies.

It also suggests a lower level of sophistication and liquidity in UK derivatives market. The value of developing a basis for benchmarking good management practice in the use of derivatives to manage financial price risk represents an important area of ...