Aarhus School of Business, University of Aarhus
January 2009
An empirical study of strategic
approaches to foreign exchange risk
management used by Danish
medium-sized non-financial
companies
Master Thesis - M.Sc Finance and International Business
Author: Marianna Andryeyeva Hansen
An empirical study of strategic approaches to foreign
An empirical study of strategic approaches to foreign
An empirical study of strategic approaches to foreign
An empirical study of strategic approaches to foreign
exchange risk management used by Danish medium
exchange risk management used by Danish medium
exchange risk management used by Danish medium
exchange risk management used by Danish
medium----sized non
sized non
sized non
sized non----financial companies
financial companies
financial companies
financial companies
Abstract:
The study empirically investigates the strategic foreign exchange risk management practice by Danish medium-sized non-financial, not-listed companies that are involved in international activities. The study shows that interaction between financial and operational hedges exists in the management of operating exposure and that operational and financial strategies are seen as complements to each other. The empirical results supported the hypothesis that the hedging strategies of the companies depend on their previously build flexibility. Multinationality and foreign exposure were significant explanatory factors for the importance and application of various hedging strategies. On the aggregate level, the risk management objective of the companies and the involvement of both the operational and financial departments in the risk management were significant factors in explaining the importance and application of the operational hedging strategies. The size of the company exhibited significance in explaining the importance and application of the financial hedging means.
Key words: risk management, operating exposure, financial instrument, operational hedging, real options
Author: Marianna A. Hansen
Email: mariannahg@gmail.com
Studentno.: ma71942
Examno.: 277911
Study: M.Sc. in Finance and International Business
AKNOWLEDGEMENTS
I would like to express my deepest gratitude to the 368 financial directors that despite their enormous workload found time and showed interest in my survey; to my supervisor for his clear and constructive advises; to my dear husband for endless support and care; to our son for being a very patient little boy for the past half a year; and to our nearest family for their help and support…..
Table of context
1. Introduction... 1
2. Theoretical background... 3
2.1 Foreign exchange rate operating exposure... 3
2.2 Risk management of the exchange rate operating exposure ... 5
2.2.1 Financial and operational hedging approaches ... 5
2.2.2 The real options perspective on operational hedging... 7
3. Empirical literature review... 9
4. Research design and data collection ... 13
4.1 Research methodology
... 134.1.1 Target population definition... 13
4.1.2 Questionnaire design... 19 4.1.3 Survey implementation ... 21
4.2 Survey response... 23
4.2.1 Response rate ... 23 4.2.2 Survey feedback ... 244.3 Response bias... 25
5. Univariate analysis of the survey data ... 28
5.1 Descriptive statistics for the sample of the researched companies... 28
5.2 Descriptive statistics for survey responses... 29
6. Empirical results... 52
6.1 Hypotheses setting
... 526.2 Correlation analysis
... 556.3 Regression results... 55
6.2.1 Factors behind the importance of financial and operational means for a company’s risk management of foreign exchange operating exposure ... 56
6.2.2 Factors behind the application of financial and operational means for the companies’ risk management of foreign exchange operating exposure ... 60
6.2.3 Limitations and robustness considerations ... 63
7. Conclusions... 65
List of references... 67 Appendices...I
1. Introduction
Exchange rates represent one of the major sources of macroeconomic risk for a non-financial company. In the long run exchange rate changes influence a company’s volume of foreign trade, the costs of foreign purchases, alter its domestic and international competitive profile and the structure of foreign markets in which the company operates. These changes have a large impact on small and internationally oriented economies (Bodnar and Gentry 1993), like Denmark. In the second part of 2008 several periodicals sounded the alarm about the downsizing of Danish export and the weakening of the competitive position of Danish non-financial companies.1 The situation is conditioned by a combination of the economic recession in Europe and in the rest-world and by the strengthening of the Danish currency2. The Danish krone has reached its strongest real value of the past 25 years and it is highly volatile compared to other important currencies.3 The revaluation of the national currency makes Danish products more expensive and less competitive on the world market. Therefore the search for the optimal strategy to manage currency risks is essential for Danish non-financial companies. This is especially true for the medium-sized companies since they constitute a very significant part of the Danish industry structure.4
Academic works on foreign exchange risk management have also underlined the significance of the impact of exchange rates changes on a company’s operational cash flows and competitive position (Martin and Mauer 2003). From a theoretical perspective the researchers agree that the correct risk management of the impact of exchange rate changes on a company’s operations should involve strategic approaches (Glaum, 1990). In order to improve the decision-making process the issue of integration of strategic approaches to foreign exchange risk management should also be addressed by practitioners. However, the empirical research of foreign exchange risk management practice is primarily concentrated on the usage of tactical tools. Thus, the theoretical conclusions with regards to the strategic foreign exchange risk management are not corroborated by the actual management practice to a desirable extent. Therefore
1 See for exsample Nielsen J., “Eksporten til Tyskland ned i gear” , Børsen, d. 22.08.08, s. 22; Størup J.
økonom I Fionia Bank, ”Dansk eksport sendt till tælling”; Fyens Stiftstidende, d. 27.10.2007, s. 18 and ”Store økonomiske udfodringer for Europa”, Berlingske Tidende, d. 23.08.2008, business, s. 12
2 Halskov K. , “Europa på randen af recession”, Jyllands Posten, d. 15.08. 2008, s. 12
3 Skovgaard L.E., “Historisk stærk kronekurs”, Berlingske Tidende, d. 13.07.2008, business, s. 7 4 www.danishexporter.dk/scripts/danishexporters/economy.asp
the aim of the present study is to fill the gap and provide additional empirical evidence on the companies’ strategic approaches to foreign exchange risk management. Specifically, by conducting a survey and applying univariate and regression analyses to understand the behavior of a sample of Danish medium sized non-financial non-listed companies that are involved in international operations in regard to the strategic foreign exchange risk management. Therefore the central research goals are:
1. To provide empirical data about the actual and potential strategies used for the exchange risk management by Danish medium-sized non-financial companies and in particular, answer the question if the interaction between operational and financial hedges exists in the actual risk management practice of companies;
2. By the means of regression analysis to examine the relations between company specific characteristics and the importance and application of financial and operational approaches towards the management of foreign exchange operating exposure and particularly the companies’ adoption of various real options strategies as a response to exchange rate changes.
The research in hand is organized as follows: section 2 provides a theoretical background and explains the concept of operating exposure and the possible ways of its management. Section 3 comments on previous empirical research on the topic of strategic approaches used for the foreign exchange risk management. Section 4 describes the research methodology. Section 5 provides a descriptive statistical analysis of the survey responses. Section 6 presents the empirical results. And finally, the conclusion is given in section 7.
2. Theoretical background
Three types of a company’s exposure to unexpected exchange rates fluctuations are identified in the finance management literature5. Translation exposure is exposure of the company’s financial accounts to changes in exchange rates. It is the risk that the financial figures reflected in the accounting statements will change their value as a result of the translation of foreign accounts into the domestic currency. This type of exposure is relatively easy to identify and measure since gain or loss from exchange rate changes is recorded in financial reports. Transaction exposure is known as exposure of the company’s future cash flows to the fluctuations in exchange rates. In this case, the risk is attached to already establish contractual agreements with determined future cash flows and a determined time horizon. Thus, transaction exposure is measured by the extent to which changes in the exchange rates will effect the domestic value of accounts receivables and payables, including loans and investments, denominated in foreign currency during the actual time of a contract. On the contrary, operating exposure is exposure of the possible future operating cash flows to the changes in exchange rates during an undetermined time horizon. In this case the risk is connected to the company’s operations and competitive position. That is why operating exposure is also referred to by some academics as economic or competitive exposure6. The main focus of the present thesis is on the management of operating foreign exchange exposure by companies.
2.1 Foreign exchange rate operating exposure
Adverse movements in exchange rates with time change the macroenvironment of the company and effect its future operating cash flows. If discounted, these cash flows become equal to the company’s net present value (Glaum 1990). The degree to which changes in operating cash flows will effect the company’s market value due to the unexpected changes in the exchange rates is referred to as the foreign exchange operating exposure of the company. Operating exposure is characterized by a longer, undetermined time horizon compared to translation or transaction exposure. In the long run, nominal exchange rates adjust to offset cumulative differences in foreign countries’ rates of inflation (Lessard 1986, p. 150) so the purchasing power of home or
5 See for example Adler and Dumas (1984), Srinivasulu (1981), Lessard (1986). 6 See for example Booth and Rotenberg (1990), Belk and Edelshain (1997).
foreign currency in a given country on a certain date in the future will differ from its anticipated value (Adler and Dumas 1984 p. 42). Thus, the company’s operating exposure to exchange rate fluctuations is exposure to changes in real exchange rates. That is why the exposure is broad in scope, since unexpected changes in real exchange rates effect not only actual but also potential cash flows by the means of altering the structure of such operational variables as cost, volume, price, revenues and by changing the competitive position of the exposed company (Srinivasulu 1981, Lessard 1986, Booth and Rotenberg 1990). On top of that, the exposure is enhanced by the changes in the identities and policies of competitors, suppliers and customers (Loderer and Pichler 2000).
The risk of undesirable changes in the company’s value resulting from unexpected changes in the real exchange rates is presented for companies across both domestic and international markets. Choi and Kim (2003) in their analysis showed that both internationally involved companies and companies with only domestic operations are exposed to foreign exchange risk in the long run. The present research, however, concerns only those companies that are at least to some degree involved in international operations.
Considering the nature of operating exposure it is obvious that it has the greatest consequences for a company’s development and growth compared to other types of exposure. Glaum (1990) highlighted the concept of operating exposure as the prior foreign exchange exposure academic concept. The results of the survey of the British Times 1000 corporations conducted by Belk and Edelshain (1997) revealed that operating exposure is also important for practitioners since the majority of the companies defined this particular exposure as the most significant in the total foreign exchange rate exposure. However, despite the fact that the companies recognize that they are highly vulnerable to the elements of operational exposure, several studies witnessed that in their practice the companies mostly manage transaction and translation exposures (Lessard 1986, Hakkarainen et al 1998, Bodnar et. al 1998). The most obvious explanation of this is that the broad scope of the operating exposure makes it impossible to measure it only via analysis of the companies’ financial accounts and statements. Therefore difficulties in quantification and prediction of operating exposure due to many uncertain elements make it difficult to choose the
appropriate management tools to manage it. Furthermore, management of the long-term exposure to currency fluctuations is costly and time consuming. It would definitely require a great deal of the company’s resources in order to gather the necessary information for the analysis, which means that management of the operating exposure would be impossible for the companies restricted in their resources. Belk and Edelshain (1997) pointed out that insufficient knowledge of the phenomenon also prevents managers from considering all possible alternatives and make them concentrate on exposures that can be assessed ex post. Lessard (1986) emphasized, that not all managers realize the fact that management of the operating exposure is already incorporated into the operational decisions of the company. The following section will discuss the approaches that can be used for the risk management of operating exposure.
2.2 Risk management of the exchange rate operating exposure
2.2.1 Financial and operational hedging approaches
To reduce exposure to unexpected currency fluctuations in the long run, corporate risk management can resort to financial and operational approaches (Srinivasulu 1981, Lessard 1986, Aggarwal and Soenen 1989, Chowdhry and Howe 1999, Hommel 2003, Carter et all. 2003, among others). Financial approach involves the usage of various financial instruments, such as forward or futures contracts, options, and swaps. The goal of financial hedging is to increase value by minimizing the variance of the net cash flows. Financial instruments are considered to be an appropriate tool for minimizing the risk from near-term exposures that have predetermined future cash flows and can be relatively easily quantified (Srinivasulu 1981, Lessard 1986, Bodnar et al. 1995). The potential of the financial instruments to manage operating exposure to exchange rate changes is limited due to the broader scope of exposure, its longer time horizon and existing uncertainty in the underlying cash flows in addition to the exchange rate uncertainty. The elements of operating exposure effect all parts of the company and therefore cannot be exclusively look upon as a financial phenomenon. For example, financial means become irrelevant hedging mechanisms when changes in the exchange rates alter the competitive position of the company or results in loss of various business opportunities.
According to the risk management literature, management of the operating exposure should be based on the strategic coordination of the activities in company’s financial and operational areas. The strategic financial approach to the management of the operating exposure is based on the proper choice of the financing base and may involve the choice of alternative credit lines in different currencies or even in different countries. Operational strategies may involve timing and choice of new markets and market segments, thorough pricing, choice of alternative sourcing or production locations, planning of production mix and production inputs. The main goal of the operational approach is to minimize the real effects of the future changes in exchange rates and find correct response to exchange rate changes (Glaum, 1990). Furthermore, the involvement of the operational approaches to the foreign exchange risk management allows a company not only to reduce exposure to exchange rate changes but also to achieve extra profit in the presence of favorable exchange rate conditions (Kogut and Kulatialka 1994, Bartram et al. 2005).
The significant part of the theoretical discussion and further empirical research on the topic of strategic approaches to foreign exchange risk management is devoted to the problem of interaction between financial and operational hedges in the management practice of companies. Based on the real options framework, Hommel (2003) presents arguments that for a non-financial company operational hedging is definitely a strategic complement to financial hedging. However the extend to which each of these types of hedging will be used depends on the company’s previous investments into operational flexibility. In the absence of previous investments into flexibility, the company’s hedging strategy will be, to a greater extend, built on the usage of various financial hedging techniques. Operational hedging in this case will be used only as a substitute in the absence of the necessary financial instruments. On the contrary, operational flexibility incorporates various real options that provide a company with the possibility to freely use operational and financial means as hedging compliments. Thus, a pure exporter will mainly rely on financial instruments as a hedging strategy and a company with subsidiaries dispersed in different locations with different currencies will be actively involved in operational hedging by shifting production and sourcing as a response to exchange rate movements. Chowdhry and Howe (1999) stress that operating hedging is important for the management of the long-term exposures. Furthermore, after examination of the conditions under which a company would resort
to operational hedging they come to the conclusion that both exchange rate and demand uncertainty should be present. However, Hau (1999) refuted the demand uncertainty as a necessary condition and stated that an operational response to exchange rate changes is simply an exercising of real options incorporated into previous investments of a company.
The ability to utilize strategic hedging techniques implies the involvement of various corporate departments into the hedging process and the incorporation of the ways of measurement and management of the exposure into the corporate management policy. Srinivasulu (1981), Glaum (1990) accentuated that the policy of dealing with unexpected currency fluctuations by the means of correctly made marketing, production, sourcing and financial decisions must constitute a part of the long run corporate strategy of the company. Furthermore, in order to correctly implement strategic approaches, the financial department should closely interact with operational departments (Lessard 1986, Capel 1997). Miller (1998) stresses that in order to assess and manage operating exposure a company should regularly analyze its competitive position, input supply, market demand and technological risks.
2.2.2 The real options perspective on operational hedging
The real options perspective serves as a good framework to explain possible operational hedging strategies for the management of foreign exchange risk. The main focus of the real options framework is on the value of flexibility (Triantis 2005). Flexibility, incorporated in the company’s previous investments and operational decisions, provides it with a set of real opportunities like to expand, to defer future investments, to shut down operations completely or temporality, to switch inputs or outputs. The available set of real opportunities allows the company not only to minimize or shift the risk but also to benefit from the present uncertainty.
Kogut and Kulatialka (1994), argue that the operational flexibility of a company involved in international activities is incorporated in its network of geographically dispersed foreign subsidiaries. The existing network provides the company with a flexibility that is equivalent to the portfolio of real options that can be exercised in order to hedge the company’s future cash flows. Thus, depending on changes in the exchange rates, the company’s response can for example include a shift of production
between two manufacturing plants located in different countries, the placement of a plant in one of the foreign locations, an increase in the production in one of countries or a decrease in the other, or an introduction of new products on the market.
In line with Kogut&Kulatialka, Allen&Pantzalis (1996) also argued that the company’s operating flexibility built-in its international network should be perceived as portfolio of real and financial options. These options represent the company’s possibilities to manage operating exposure by shifting factors of production and various resources across foreign countries within the company’s international network.
Caple (1997), Carter et al. (2003), Driouchi et al. (2006) emphasize the fact that based on the real options framework, operational flexibility gives a company the opportunity to exploit favorable developments in the exchange rates besides the opportunity to minimize the negative impact of exchange rate changes. Similar to the above mentioned academics they explained that a company can be involved in operational hedging by realizing existing real possibilities through operational and multinational flexibility.
3. Empirical literature review
The empirical evidence on strategic management of operating exchange rate exposure presented in the financial literature is rather limited. Most of the empirical studies concerned with foreign exchange exposure risk management are devoted to the usage of the short-term financial hedging instruments and the topic of the involvement of strategic approaches to the foreign exchange risk management by companies is researched only marginally. The purpose of the present chapter is to comment on the scarce empirical research conducted on the interaction between financial and operational approaches to foreign exchange risk management and companies’ adoption of various real options strategies as a response to exchange rate changes.
According to the results of one the most significant surveys within the field of risk management conducted by Bodnar et al. (1998) the majority of companies concentrate their risk management activities on the management of directly observable near term currency exposures. Only 12 % of the companies responded that they manage longer term exposures and 11% manage competitive exposure. The goal of the conducted survey was to investigate derivative usage for the risk management purpose, despite that, they found indication that companies consider both financial and operational means for their risk management activities. 14% of the responding companies stated that they do not use derivatives because they can effectively manage their exposures by resorting to various operational approaches. The researchers, however, have not attempted to study those operational approaches more detailed and no empirical analysis has been performed on the factors that determine the company’s choice of hedging approaches. Furthermore, the study was conducted on a sample of large companies. As the result of a survey conducted among large British industrial multinational enterprises Joseph (2000) also came to the conclusion that the risk management of the majority of the companies is based on the usage of derivatives and the companies apply a limited number of operational strategies. According to his results the choice of internal hedging techniques can be explained by the company’s degree of internalization, though in general a company’s specific characteristics serve as a better explanatory factors for company’s choice of external techniques.
Rangan (1998) in his empirical analysis of the US, European and Japanese multinational manufacturing companies reached the conclusion that companies do shift production in response to the changes in exchange rates but these operational shifts are relatively modest. However, the conclusion was made based on the analysis of the data on industry and country level and the results were not supported by the actual data from companies. Bradley and Moles (2002) investigated the degree to which non-financial companies in UK that are listed on the stock market use strategic approaches in their foreign exchange exposure management. Their survey results revealed that companies do undertake various real action strategies as shifting the country of their sourcing of inputs or changing their production location as the response to movements in exchange rates. However, in line with Rangan’s conclusions, only one third of the respondents in their study indicated that they shift productions and sourcing locations as a response to exchange rate changes, thus operational shifts are relatively modest. Additionally, they found that most of the companies at least to some degree attempt to match currency denomination of costs and revenues cash flows. Besides, the companies also involve such strategic financial instrument as the choice of currency denomination of their foreign debt. Therefore their general conclusion is that the companies prefer to use a combination of the financial and operational approaches in their operating exposure risk management. Furthermore, they found the evidence that the degree of adopting strategic approaches will be higher for those companies that have a network of foreign subsidiaries and the degree of resorting to operational hedges is related to the extent of involving operational departments in the foreign exposure risk management.
Allayannis et al. (2001) studied exchange rate exposure management strategies of 265 US multinational non-financial companies. According to their results a company can benefit only from supplementary usage of financial and operational hedging techniques. However, this study was based on the information presented in the COMPUSTAT database and operational and financial strategies were proxied by several variables received from the financial reports available from the companies therefore the actual strategies of the companies were not investigated. Another empirical study of US multinationals by Pantzalis et al. (2001) revealed that operational hedges are significant for the management of foreign exchange risk. But this study was concerned with the impact of operational hedges on the foreign exchange exposure itself rather than with investigation of the operational strategies that are adopted by companies or factors that
influence companies’ choices of operational hedges. Similar to Pantzalis, Carter et. al. (2003) also examined the effect of both operational and financial hedging techniques on foreign exchange exposure. According to them, financial and operational strategies are effective mechanisms in case of both negative or positive exchange rate changes. Furthermore according to their regression results the hypothesis that operational hedging techniques can be considered as real options adopted by companies holds from two perspectives. First of all, the ability of the companies to adopt operational approaches to foreign exchange risk management is incorporated in the existing network of foreign subsidiaries of companies. Thus the companies that have no foreign subsidiaries do not possess those operational hedging options that the companies with the network of foreign subsidiaries do. Second of all, the companies that adopt operational hedges besides reducing their exposures to adverse currency movements have an option to receive extra profits from beneficial exchange rate positions. In line with Allayannis et al. (2001), Pantzalis et. al. (2001), Carter et. al. (2003) in a similar empirical study Choi and Kim (2003) also examined currency exposures of US firms and found the evidence that interaction between operational and financial hedging exists.
Marshall (2000) compared risk management practices among UK, USA and Asia Pacific multinational corporations. He found that companies in Asia Pacific adopt significantly different approaches to their foreign exchange exposure management than UK and US companies. He also found that for the management of operating exposure, pricing strategy was the most popular. The research conducted by Marshall was oriented on the identification of regional differences for the management of transaction and translation exposures, thus a limited amount of attention was paid to the strategies the companies used for the management of operating exposure.
Driouchi et al.(2006) explored the relationship between the general performance of companies and their operational capabilities from the perspective of real options. Though this study does not directly investigate foreign exchange risk management practice or exchange rate exposure of companies, it provided additional evidence that the companies that posses various real options operational capabilities incorporated in their international and operational flexibility can in general reduce risk and benefit from advantageous opportunities. In the empirical study by Faseruk and Mushara (2008) which focused on exchange risk management, the authors pointed on the value
enhancing power of the combination of financial and operational foreign exchange risk management activities. According to their results, in those cases when companies jointly involve financial and operational hedges the market-to-book value of companies was increased by 14% and market value-to-sales by 40%. The research however, was only addressed to the risk management practice of large Canadian non-financial companies and risk management activities were proxied by variables taken from the financial statements of the companies.
Based on the sample of Danish companies two empirical studies shed some light on the strategic approaches of foreign exchange risk management by Danish companies. Kuhn (2007) investigated the risk management practice of Danish medium sized companies. Though his primary interest of the research was concerned with the usage of financial instruments, he found that about 25 % of the companies consider the usage of operational means in general as an important tool in managing foreign exchange risk. Using a sample of Danish listed non-financial companies Aabo and Simkins (2005) found that interaction between financial and operational hedging techniques for foreign exchange risk management exists and companies do use real options strategies as the response to exchange rates changes. If taken individually, company-specific characteristics like the company’s size, export and the number of foreign subsidiaries failed to explain the company’s choice to undertake real options strategies. Only a combination of the mentioned characteristics was a statistically significant explanatory factor for the likelihood of adopting by companies real options strategies. The study, however, was focused on large listed companies and therefore the results can not be transferred to the medium-sized companies. Furthermore, the authors have not analyzed the significance of the factors in explaining the companies’ choice between financial and operational hedges.
As it is seen from the mentioned above studies, most of the empirical research on the topic of interaction between financial and operational approaches to foreign exchange risk management is addressed to large companies and yet little attempt is made to study which strategies are important for the companies and to which extent those strategies are used. The results of all the studies, however, provide direct evidence that companies do manage foreign exchange exposure by applying strategic approaches and their application is a significant value enhancing activity for companies.
4. Research design and data collection
4.1 Research methodology
The empirical research conducted for the purpose of the thesis is designed to provide a “snapshot” of the strategic foreign exchange risk management practice of Danish medium-sized companies. In order to test a range of hypotheses presented in the academic and empirical literature on the topic and to answer the research questions cross-sectional data was utilized. A self-completion approach was applied to collect the data about the companies’ foreign exchange risk management practice. For this purpose a structured electronic survey was developed and delivered to the target group of respondent companies. Additional company specific data necessary for the research was obtained through the web-direct database7. The following sections provide a description of the sampling process and survey design, administering and response. A detailed descriptive analysis of the received data will be presented in chapter 5.
4.1.1 Target population definition
The research in hand is targeting Danish medium sized non-financial companies that are not listed on the stock exchange. The web-direct database was used in order to frame the group of the Danish companies relevant to the research. In the database companies are grouped into 20 economic sectors according to their economic activity based on the NACE statistical classification of economic activities8. 1055 companies from seven economic sectors were selected as target population for the survey based on the presented data in the database on the 2nd October 2008. The selection process included 5 steps that are presented in the table 1 below and are discussed in detail in the following paragraphs.
7 The WEB-DIRECT database presents data about all companies registered in Denmark and facilitates
search of companies by their type, industry, accounting figures for the last 5 years, structure and ownership type, registration information, names of owners, directors and management. WEB-DIRECT is developed and supported by Experian A/S. A demo version is presented on www.kob.dk. The version used for the purpose of the thesis was available in the library of Aarhus School of Business.
8 NACE stands for "Nomenclature Generale des Activites Economiques dans I`Union Europeenne"
(General Name for Economic Activities in the European Union). The system is the European standard for industry classifications. The latest version that came into effect from 01.01.2008 is based on the "International Standard Industrial Classification of all economic activities" (ISIC) of the United Nations. A detailed classification is presented in Appendix 1.
Table 1: Stages of the target population selection process
Table describes the five stages of the target population selection process and reports the number of companies included after each step.
Stage Number of companies included
Step 1 Restricting to non-financial non-listed companies 120407 Step 2 Limiting to medium sized companies:
2.1 companies that have employees between 50 and 499 3208 2.2 companies whose total balance is between 75-750 million DKK 1434
Step 3 Excluding duplicate companies 1379
Step 4 Excluding economic sectors with less than 20 companies 1307 Step 5 Excluding companies with a foreign mother company 1055
Step 1: Restricting to non-financial non-listed companies. As the first step of the selection process from the total number of companies presented in the Web-direct database only companies were chosen that are private and are not listed on the stock exchange and whose main activities do not involve financial and insurance services. Private companies were defined as those that are registered as “Aktieselskab” (A/S) or “Anpartsselskab” (ApS) 9. Non-financial companies were defined as all those that are not registered under section F “Financial and insurance services” in the database. As the result 120407 companies were suggested in Web-direct. .
Step 2: Limiting to the medium-sized companies. The criteria for the medium sized companies were chosen from the official definition of small and medium sized companies adopted by the European commission and applicable within the EU from January 1st, 2005. According to Commission Recommendation C (2003) 142210 three criteria are used in order to distinguish between micro-, small- and medium- sized enterprises. According to the definition medium sized companies are companies that have headcount of no more than 249 employees and whose annual turnover is less than or equal to €50 million and/or whose annual total balance sheet is less than or equal to €43 million (see figure 1 below). However, when applying the definition it is important to realize the three following points. First of all the EU Recommendation refers only to the ceilings for staff and financial criteria. This means that it is stated directly that
9 “
Aktieselskab” is a private business entity where shareholders share a common responsibility. “Anpartsselskab” is a private business entity with a limited responsibility. The British equivalent of “aktieselskab” and “anpartsselskab” is “public limited company” (www.ordbogen.com)
10 “Commission recommendation of 6 May 2003 concerning the definition of micro, small and
medium-sized enterprises (notified under document number C (2003) 1422)”. Official Journal of the European Union, 20.05.2003.
medium sized companies should have a staff of less than 250 but it is not directly stated that it should have no less than 50 employees (the staff criteria for small enterprises).
Figure 1: Criteria that are used for the definition of the micro-, small- and medium-sized enterprises. Source: European Commission Recommendation C (2003) 1422.
The same is true for financial criteria. This causes a problem in defining the enterprise category in the case when, for example, the company has less than 50 employees but the total balance is equal to € 43 million. This, nevertheless, can be indirectly resolved through the second important issue in Recommendations. According to them, the staff headcount criterion is considered the main criterion11. And in the case of needed administrative simplifications, the single criteria, staff headcount, can be applied12. Thus, for the purpose of the present research, the first criteria that was applied to find the number of medium sized companies in the total number of non-financial non-listed companies in Denmark was the number of employees.
Finally, it is noted in the Recommendation that the financial criteria are a necessary addition to the staff headcount since it “grasp the real scale and performance of an enterprise”13. Furthermore, it is possible to use one or both of the financial criteria. However, according to §5 of the above mentioned Recommendations it is not advisable to use annual turnover as sole financial criterion since it depends on the nature of the economic activity of the companies14. That is why it is recommended to use in combination with the total balance criterion. Otherwise, the total balance can be used separately. Considering the fact that the targeted companies lie across several economic sectors and that the indicator of the total balance was presented for all the companies in 11 OJ , L 124/37, 20.5. 2003, p. 4 12 OJ , L 124/37, 20.5. 2003, p. 7 13 OJ , L 124/37, 20.5. 2003, p. 4 14 OJ , L 124/37, 20.5. 2003, p. 5 Medium Small Micro Enterprise catogory < 250 < 10 < 50 and/or ≤ ≤ ≤ ≤ €50 million ≤ ≤ ≤ ≤ € 43 million ≤ ≤ ≤ ≤ € 10 million ≤ ≤ ≤ ≤ € 10 million ≤ ≤ ≤ ≤ € 2 million ≤ ≤ ≤ ≤ € 2 million Criteria Headcount Annual turnover Annual total balance
the Web-direct database, the total balance was the second criterion applied in order to confine the group of medium sized companies.
The application of the staff and the total balance criteria was conducted in the following way. At the beginning it was decided to choose those companies that have employees from 50 to 250. However, there is a function for sorting companies according to the number of employees is based on the min/max interval in web direct. Thus, it facilitates a search for companies that have from 50 to 199 or from 50 to 499 employees. Intuitively, larger of medium sized companies are interesting for the research since they possess more opportunities for various strategic foreign exchange risk management tactics. That is why it was decided to extend the upper bound and cut down total number of 120407 to those companies that have from 50 to 499 employees. This resulted in a list of 3208 companies.
The indicator of the total balance for the accounting year 2007 in the Web direct database was used as the financial criteria15. In order to facilitate the search in the database the euro equivalent was translated into Danish krone using the euro/krone exchange rate on the 1st of January 200816 and then rounded to the whole. As the result the criteria of total balance between 75 and 350 million DKK was obtained. However, using the same logic as for extending upper bound of the staff headcount, the total balance criteria was decided to be set between 75 and 750 million DKK. Finally, 1434 medium sized non-financial non-listed companies were singled out.
Step 3: Excluding duplicate companies. When initiating a search for companies across two or more economic sectors in the Web-direct database, companies that belong to more than one economic sector will appear on the list more than once. That is why the list of 1434 companies was checked on duplicated companies and as the result 1379 companies were left based on their main economic activity.
Step 4: Excluding industries with less than 20 companies. Analysis of the distribution of the 1379 companies across the economic sectors showed that in 13 out of 20 economic
15 The
Web-direct database suggests a “total balance for the accounting year 2007” as a search criterion
for the total balance. However, it should be noticed that the presented data for the total balance after applying the mentioned search criterion corresponds to the yearly total balance of companies with different closing dates since for some companies the accounting year is not the same as calendar year. Therefore for 717 (68%) of the companies the total balance presented with closing date 31 December 2007, for 268 (25%) – during second half of 2007 and for 70 (7%) – during first half of 2008.
sectors the number of companies didn’t exceed 1% of the total selected population (see Appendix 2 for details). That is why in order to eliminate noise in future calculations it was decided to remove companies from economic sectors with less than 20 companies from the target population (equivalent 1,5% of the total 1379).
Step 5: Excluding companies with a foreign mother company. Finally, companies that
have a foreign mother company were excluded from the target population. The research in hand aims to investigate the behavior of the Danish companies in regard to the strategic exchange risk management. In those companies that are registered in Denmark but are subsidiaries of a foreign company, the risk management policy is mostly determined by the holding company and reflects the specifics of the foreign management practices. Thus companies that were stated as part of foreign holding in the Web-direct database were excluded form the target population.
As the result of the sampling process 1055 Danish medium sized financial non-listed companies were included in the target population. (See table 2 below).
Table 2: Distribution of the companies from the target population across economic sectors
Economic
activity sector Name
Indus try code N % C MANUFACTURING 10-33 455 43.13% F CONSTRUCTION 41-43 62 5.88% G
WHOLESALE AND RETAIL TRADE; REPAIR OF MOTOR VEHICLES AND
MOTORCYCLES 45-47 308 29.19%
H TRANSPORTATION AND STORAGE 49-53 91 8.63%
J INFORMATION AND COMMUNICATION 58-63 53 5.02%
M PROFESSIONAL, SCIENTIFIC AND TECHNICAL ACTIVITIES 69-75 54 5.12%
N ADMINISTRATIVE AND SUPPORT SERVICE ACTIVITIES 77-82 32 3.03%
TOTAL 1055 100.00%
INDUSTRIALS 517 49.00% SERVICES 538 51.00%
The majority of the companies included in the survey is represented by companies from the “manufacturing” and the “wholesale and retail trade and repair of motor vehicles and motorcycles” economic sectors – combined 72,32% (43,13% and 29,19% respectively). Approximately the same number of companies, around 5% of the total target population, was included from each of the “construction”, “information and communication” and “professional, scientific and technical activities” sectors”. Almost
9% of the included companies were from the “transportation and storage” sector. And the lowest number of companies equal to 3% was included from the “administrative and support services activities” sector.
Despite the fact that companies from industries where the number of medium-sized companies was very small were excluded from the target population, a substantial difference in the number of companies that was included from each economic sector was still presented. That is why it was decided to make an extra grouping of companies according to their industry characteristics. Therefore, industries were divided into two main groups used in the future analysis: industrials (that included sectors C “Manufacturing” and F “Construction”) and services (that included sectors G “Wholesale and retail trade; repair of motor vehicles and motorcycles”, H “Transportation and storage”, J “Information and communication”, M “Professional, scientific and technical activities” and H “Administrative and support service activities”). Such a structural division was made based on the logic suggested by Andersen (2005) p.38ff. The main characteristic of industrials is that their final product is “physical” goods, whereas the final product of service companies has no physical form. It is assumed that the business process of these two groups would be build differently and thus there will be difference in their foreign exchange risk management approaches.
A more aggregative division allowed us to obtain two suitable groups for further analysis with an almost equal number of companies. The “industrial” group included 49% of companies from the target population and the “service” group – 51%. It was decided to use this division in the descriptive and regression analyses presented in the following chapters. The descriptive statistics for the whole target population and with differentiation across industrial and service groups is given in table 3 below. On average, a company included in the target population has total balance of DKK 195 million (middle value DKK 143 million) and employs 147 workers (middle value 118). 517 companies (49,00%) of companies were defined as the industrial group and 538 (51,00%) as the service group. The distribution of both the total balance and the number of employees indicators is not normal. Both distributions are very picked and skewed to the right. There was found no statistically significant difference in the mean values for the indicator of the total balance separately for industrial and service group.
Table 3: Descriptive statistics for the target population of 1055 Danish medium-sized non-financial companies
The table reports descriptive statistics for the target population of the companies consisting of the 1055 Danish non-financial medium-sized companies. The table provides data for the two indicators that were used for the definition of medium-sized companies: the total balance and the number of employees. The descriptive statistics is presented for the whole population and for the groups of industrial and service companies. P-value for the t-statistics that was estimated for comparison of mean values for two mentioned groups is also reported.
Total balance (DKK million) Number of employees
total industrials service total industrials services
min 75 75 75 50 50 50 max 745 711 745 499 498 499 skevness 1,79 1,85 1,75 1,42 1,27 1,59 kurtosiss 6,1 6,2 5,9 4,7 4,2 5,4 median 143 146 142 118 126 109 mean 195 193 198 147 155 139 t stat (p-value) 0,5212 0,0051 n 1055 517 538 1055 517 538 % 100,00% 49,00% 51,00% 100,00% 49,00% 51,00%
On average the total balance of the industrial companies is slightly but not significantly smaller: DKK 193 million for industrials against DKK 198 million for service companies. However, a statistically significant difference17 was revealed in the mean values for the indicator of the number of employees. The average number of employees is higher for industrials (155) than for service companies (139). Therefore the service companies included in the target population are on average slightly bigger in terms of total balance, but industrials are significantly bigger in terms of the number of workers employed.
4.1.2 Questionnaire design
Data on the strategic foreign exchange risk management practice of the companies is not readily available in official databases, especially when concerning medium sized companies. Therefore, to collect data on strategic foreign exchange risk management practice of the Danish medium sized companies an electronic self-completed questionnaire was developed and delivered to the target population of companies. The structure of the questionnaire was inspired by the empirical studies conducted by Josef (2000), Bradley and Moles (2002), Aabo and Simkins (2005), Kuhn (2007). Some
questions are similar but not identical. A full version of the questionnaire is presented in appendix 3.
The questionnaire included 23 closed-end questions concerning the international involvement of the companies and their strategic foreign exchange risk management approaches. The funnel approach was used to design a questionnaire. Therefore the most general questions were asked first, followed by more specific questions. The questionnaire was divided into two sections. Section A was designed as an introductory section where questions concerning the international activities of the company were asked. The research in hand is targeting only companies with international operations. However, the population of the 1055 companies included both companies with and without international activities since the information about the companies’ international involvement was not presented in Web-direct. In order to eliminate companies oriented purely on the domestic market question 1 in the in the first section was designed as a screening question that allowed companies without international operations to terminate the questionnaire immediately. Questions 2 –7 were designed to provide information about the degree of the company’s international involvement and flexibility as well as to stimulate the participants to think about their international operations and focus their attention on the topic.
In the Section B direct questions about the company’s strategic approaches towards foreign exchange risk management were asked. Questions 8-15 were designed to collect information about the importance and usage of financial and operational hedges. Questions 16-17 were concerned with the company’s actual and potential real options strategies as the response to foreign exchange rate changes. Questions 18 – 20 were concerned with the company’s attention to the management of operating exposure. And finally, questions 21-23 were asked to provide data on a few control variables needed for the future analysis.
All the questions in the survey were designed as closed-end questions therefore all of them contained the set of predetermined answers. The category “other” in several questions was deliberately avoided in order to lower the risk that this category would be the most frequently chosen. Nominal, interval/ordinal and ratio scales were used in the questions.
One potential problem that could result in a lower response rate was identified while designing the questionnaire. The questionnaire was constructed in English while the working language in the most of the medium-sized companies is Danish. Therefore to minimize the risk that the respondents would terminate the survey shortly after having begun or that the answers would be distorted, the questions were kept brief with a simple wording and ambiguous questions or questions that include two or more issues were avoided. The questions were arranged logically so that each coming question was contributing to a better understanding of the following questions. Danish equivalents were given for some specific terms. The heading of the questions was clearly indicated and instructions on how to answer each question were given.
4.1.3 Survey implementation
To deliver the questionnaire to the target group of companies the electronic approach was utilized. This approach was chosen because it allows a quick and cheap way to deliver the survey to the target participants. Additionally, it provides quick response and a high quality of data, already converted into numerical form suitable for the analysis. The designed questionnaire was converted into electronic form as a web hosted Internet survey by the means of the StudSurvey tool provided by the IT department of the Aarhus School of Business. StudSurvey is a convenient tool that provides flexibility in the design of online questionnaires because if it’s numerous incorporated functions. Several of the functions were greatly used for the online version of the questionnaire. First of all StudSurvey allowed us to incorporate logic in the response process by adapting questions to the respondents based on their previous choices. Thus, respondents that answered “no” to the 1st question18 were automatically redirected at the end of the questionnaire and those respondents that chose category “zero” in question 519 were automatically redirected to question 8. Another important function did not allow respondents to skip the questions. This function ensured that no questions were left unanswered by the respondents. StudSurvey also gave the possibility to present the questions in the needed form and order online.
The survey was conducted during the period between the 9th of October and the 5th of December 2008. The first, invitation mail was sent on 9th of October and the last
18 Those respondents that were not internationally involved 19 Those respondents that do not have subsidiaries
reminder-mail was sent on the 26th of November. All in all one invitation mail and four follow-ups were delivered to the respondents that contained the link to the online questionnaire and the request to take part in the survey if possible. The mails sent to the companies can be divided into two types (see appendix 4 for examples). Each type of mail started with a brief description of the purpose of the survey followed by the instruction of how to participate in the survey. The bottom of the mails contained detailed contact information of the author of the survey. The first type of mails was emphasizing the possibility to participate in the survey. In the second type of the mails, the respondents were also asked to reply by email and state the reason that kept them away from the answering the questionnaire. The invitation mails were written in Danish and addressed to the financial director (økonomichefen) of the companies. In order to increase the response rate, in most cases the mails were addressed personally. The names of the financial directors as well as the email addresses of the companies were received in Web-direct. Initially, the names of the financial directors for 859 companies out of 1055 targeted were available and email addresses were available for 996 companies. The rest of the email addresses were found on the Internet sites of the companies. As a result, personal mails written with the specific name of the financial director were sent to 859 (81%) companies, invitation mails addressed generally to the financial director were delivered to 165 (16%) companies, 17 (2%) emails were sent via web pages of companies, and for 14 (1%) companies there was found no possibility to deliver the survey electronically.
The StudSurvey tool provides a quick and convenient way to send unlimited quantities of the non-personal emails. However, considering that the majority of the invitation mails were personal, it was chosen to send the emails by the regular student mail provided by ASB. To keep further control over responses each respondent received an identification code that the respondent inserted before logging into the survey. Thus it was insured that only qualified respondents participated in the survey and that it was possible to control which companies provided which responses. All responses during the survey period were collected in the ASB server where it was possible to control the statistics. The distribution of answers during the survey period can be seen in appendix 5. As the final step, after the survey period was over, the received responses were downloaded from StudSurvey in the form of numerical information presented in an
excel file. Afterwards it was checked for consistency and used in the further analysis in both Excel and the econometrical program Eviews.
4.2 Survey response
4.2.1 Response rateThe achieved response rate for the survey from the angle of the whole target population, the economic sectors and the groups of industrial and service companies is reported in table 4 below (see also appendix 6 for the response data). 368 companies have chosen to take part in the survey and an overall response rate of 34,9% was achieved. The answers were received from companies that represent all seven economic sectors included in the research. Response rate for each sector varied from a min of 30,8% (for the sector C “Manufacturing”) to a max of 53,7% (for the sector M “Professional, scientific and technical activities). 53% of the answers were received from the companies defined as service group companies and 47% from the companies defined as industrials.
Table 4: Achieved response rate for the survey
The table reports response rate for the whole target population, the companies from the seven economic sectors and the companies from the industrial and services groups. The number and the percentage of companies are given.
Response Respondents Non respondents
Economic sector
Target
population Respondents Non respondents have international operations have no international operations email received no answer C Manufacturing 455 43,13% 140 30.8% 315 69.2% 99 70.7% 41 29.3% 102 32.4% 213 67.6% F Construction 62 5,88% 33 53.2% 29 46.8% 6 18.2% 27 81.8% 9 31.0% 20 69.0% G Wholesale and retail trade; repair of motor vehicles and motorcycles 308 29,19% 98 31.8% 210 68.2% 44 44.9% 54 55.1% 52 24.8% 158 75.2% H Transportation and storage 91 8,63% 30 33.0% 61 67.0% 11 36.7% 19 63.3% 14 23.0% 47 77.0% J Information and communication 53 5,02% 22 41.5% 31 58.5% 7 31.8% 15 68.2% 4 12.9% 27 87.1% M Professional scientific and technical activities 54 5,12% 29 53.7% 25 46.3% 13 44.8% 16 55.2% 3 12.0% 22 88.0% N Administrative and support service activities 32 3,03% 16 50.0% 16 50.0% 6 37.5% 10 62.5% 6 37.5% 10 62.5% N total 1055 100,0% 368 34,9% 687 65,1% 186 17,6% 182 17,3% 190 18,0% 497 47,1% Industrials 517 49,0% 173 47,0% 344 50,1% 105 56,5% 68 37,4% 111 58,4% 233 46,9% Service 538 51,0% 195 53,0% 343 49,9% 81 43,5% 114 62,6% 79 41,6% 264 53,1%
The survey responses were received from companies that have international operations as well as companies that are oriented purely on the domestic market. Therefore the overall response rate was spread between the companies that are not involved in international operations (17,3%) and the internationally involved companies (17,6%). These 17,6% represents the effective response rate. The effective response rate is somewhat lower compared to the response rate of the significant surveys in the field of foreign exchange risk management20. However, the 1055 companies that were contacted for the purpose of the survey included both companies that are and are not involved into international activities and only those companies that have international operations are of interest to this study. Excluding not internationally involved companies from the target group would significantly improve the effective response rate. Otherwise, the number of the responding companies that are internationally involved is significant for conducting statistical calculations and generalizing the results of the survey. Therefore we conclude that the survey response is quite satisfactory.
4.2.2 Survey feedback
Various feedback was received on the survey from both companies that choose to answer the questionnaire and that refrained from it. The feedback from companies that participated in the survey was received thanks to the incorporated function in StudSurvey that allowed the respondents to leave comments about the survey. Most of the respondents that left comments pointed out that the company is a part of a holding that effects company’s freedom to choose foreign exchange risk management strategies and therefore this influenced their answers for the survey. However, there was presented no exact information for all the targeted companies about to which degree the mother company influenced the risk management policies of the daughter companies. Considering this, it was decided to make no distinction between self-standing companies and the companies that are part of a holding in the analysis of the responses. Several of the respondents acknowledged the relevance of the stated survey questions. A few of the respondents indicated that the survey was a bit too broad and answering
20 For example the response rates for the following significant surveys in the foreign exchange rate
management field are: Bodnar et al. (1995) – 26.5%, Bodnar et al. (1998) – 20,7%, Marshall (2000) – 30%, Hakkarainen et al. (1998) -71%
some questions involved deeper thinking that they would prefer. None of the comments contained any significant critique of the survey.
In the mails-reminders that was sent to the targeted population of the companies respondents were asked in the case of refraining from answering the survey to return a short email and possibly state the reason why they have chosen not to answer the questionnaire. 190 companies returned an email where they indicated their unwillingness to take part in the survey (see table 5).
Table 5: Reasons that prevented the companies from participating in the survey The table presents the reasons that were mentioned by companies that refrained to take part in the
survey. These reasons were stated in the emails sent by 190 companies.
Reason n
% to total that sent email not to participate
1 Lack of time 58 30,53%
2 English 11 5,79%
3 Have principle not to participate in any kind of survey 33 17,37%
4 Other reasons 19 10,00%
5 Stated no reason 69 36,32%
Total 190 100,00%
The majority of the companies (36,3%) that sent a message stated no reason for their lack of participation. Only a minor number of companies (5,8% or little over 1,0% of the all targeted companies) indicated that the English language was the reason why they did not take part in the survey. Thus the language of the survey turned out not to be a serious problem for the potential responders. The most widespread reason why tge companies did not participate (30.5%) was the lack of time. This sounds very reasonable since the questionnaire was sent during the time when the majority of the companies were involved in the budgeting process. It is likely that these companies represent a potential group that could help to improve the response rate if the questionnaire had been sent out on another, less busy time of the year.
4.3 Response bias
In order to control for the factor that the sample of responded companies can be considered as a true representative for the target population the differences in the mean values for several financial criteria for the respondents and the non-respondents were tested for significance. The criterion of the number of total employees and six financial criteria (total balance, net profit, capital ratio, ROA, ROE and leverage) have been
chosen for the analysis. The financial indicators were directly taken from the Web-direct database or were calculated based on the available information in Web-direct21.
Originally, the mean values were compared for the two subgroups of respondents and non-respondents by the means of the econometric program EViews. To compare the mean values the simple t-test was carried. The results of the test are presented in table 6 below.
Table 6: Comparison of the mean values of the financial indicators for the response groups by the means of the t-test
The table reports results for the t-test conducted to compare the mean values of the financial indicators for the two response groups. The mean values are reported for each financial indicator differentiated for respondents and non-respondents. The p-values for the t-statistics are provided.
Employees (number) Total balance (DKK mil) Net profit (DKK mil) ROA (%) ROE (%) Leverage (%) Capital ratio (%) Respondents (n=368) 152 199 9,7 4,1 15,2 3,5 28,5 Mean value Non-respondents (n=687) 144 194 10,6 5,3 13,2 4,2 29,3 t-statistics (p-value) 0,1863 0,5202 0,7103 0,2992 0,884 0,5126 0,8457
It was found that there are differences present in the mean values of the financial criteria for the response groups. However, no statistically significant differences in the mean values were observed for any of the indicators. Therefore, the companies that provided the response for the survey can be viewed as true representatives for the targeted population of companies.
However, in the present research the difference between the companies that represent industrial and service companies is made. Furthermore, the respondents are divided between those that are involved in international activities and those that are not. Therefore a test for the comparison of the mean values was also conducted for the response groups with further differentiation for industrials and service and for internationally involved and internationally not involved companies. The t-test allows testing the significance of the difference in the means of only two subgroups. Therefore, in order to assess the statistical differences in the mean values of each of the financial variable between the six groups of companies the analysis of variance (ANOVA) was applied. The results are presented in table 7 below.
21 Presented in Web-direct:
The number of employees; Total balance = Total Assets; Net profit; Capital ratio = Equity/ Share capital. Calculated: ROA = Net profit/Total assets. ROE = Net profit/Equity; Leverage = (Total assets - Equity)/Equity.
Table 7: Comparison of the mean values of the financial indicators for the response groups by the means of ANOVA
The table reports results for
