Stakeholder Firm-Specific Investments: Financial Hedging and Corporate Diversification

Abstract

We examine financial hedging and corporate diversification as two major risk management mechanisms. It is often believed that financial hedging and corporate diversification are substitutive means of risk management, implying that with the rapid development of the financial hedging market, there will be less need for a firm to manage risks through costly diversification. Building upon a stakeholder-based reason for firm risk management, we show that financial hedging and corporate diversification are more often complementary than substitutive. Using financial hedging instruments can increase the benefit obtained from diversification since financial hedging and corporate diversification are effective for different types of risks.