Many American corporations use derivatives conservatively, to offset risks from fluctuating currency and interest rates. But over the years, companies such as Procter & Gamble and Gibson Greetings have run into serious financial trouble using derivatives in a more dangerous fashion -- to speculate.
Is high-risk behavior common? Are shareholders in for ugly surprises if executives' derivatives bets go sour?
That has long been nearly impossible to determine, says Wharton finance professor Christopher C. Geczy. "It's not well disclosed in the financial [statements]. It could be widespread, but it's hard to say."
To get a better picture of derivatives' role in corporate finances, Geczy, Wharton accounting professor Catherine Schrand and their co-author, Bernadette A. Minton of Ohio State University, re-examined confidential responses collected in an earlier Wharton study that focused on 341 corporate respondents, 186 of which used derivatives. The companies studied were not concentrated in any one industry, but were part of a broad sample of U.S. public, non-financial firms. The researchers report their findings in a paper entitled, "Taking a View: Corporate Speculation, Governance and Compensation."
"We found that there are corporations out there, some of them very large, which have speculated, or are speculating," Geczy says. Companies reporting that they frequently "actively take positions" in currency or interest-rate derivatives on the basis of likely market movements were defined as speculators. The researchers then looked at the nature of those companies. They concluded that companies typically speculate in hopes of adding to profits, but not to "bet the ranch" to get out of financial difficulties or to hit it big. Executives who conduct the speculation typically are not renegades but instead are encouraged to do so by their superiors and board.
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