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This paper examines the impact of operational hedges of US multinational corporations (MNCs) on their exchange rate exposure. The two important contributions of this study are: First, it documents the importance of operational hedges as significant determinants of ex
change rate risk, as measured by "breadth" and "depth" dimensions of the MNC foreign subsidiary network. Second, this finding remains robust even after examining the impact of operational hedges on exposure separately for negatively and positively exposed MNCs.
INTRODUCTION
A number of empirical studies have examined the question of whether corporations are exposed to foreign exchange risk (see jorion, 1990; Bodnar and Gentry, 1993; Bartov and Bodnar, 1994, 1995; and Chow, Lee and Solt, 1997 among others). Studies to date have only uncovered a weak relationship between the stock returns of firms and exchange rate fluctuations. Yet case studies (Pringle, 1991), survey results (see Bodnar, Hayt, Marston and Smithson, 1998), and anecdotal evidence show that foreign exchange exposure is an important concern of corporations and that many corporations actively engage in risk management activities to reduce exposure.
This research expands on previous studies of exchange rate exposure by examining whether the ability of US multinational firms (MNCs) to construct operational hedges (as proxied here by the structure of the firm's multinational network) impacts their exchange rate exposure. Operational hedges are best suited for managing the impact of exchange rate changes on the firm's competitive position across markets and products and include a variety of the firm's decisions (e.g. those related to marketing, production, sourcing, plant location, treasury, etc.).
We measure exposure as the association between changes in the value of the dollar and stock returns using a timeseries regression and controlling for the overall direction of the stock market. While a few studies have investigated the impact of financial hedges (i.e. the use of currency derivatives) on foreign exchange exposure, no study to date has examined the influence of the MNC network structure on exposure. Yet, theoretical papers argue that operational hedges are more effective in managing long-run exposure, whereas financial hedges are more effective for managing short-run exposures (see Logue, 1995; and Chowdhry and Howe, 1999).
We proxy the MNCs' ability to design effective ways to manage their economic exposure to foreign exchange...