Friendly Juridical Representative Directors and Managerial Investment Decisions—Yes, the Derivatives Hedging Matter*

Under Article 27 of Taiwan's Company Act, juridical entities can designate representatives to act as directors of firms in which they invest. This institutional feature has raised concerns regarding the effectiveness with which such representative directors (particularly the friendly representative directors, FDIRs) can monitor and/or advise on firm operations. This study first examines whether FDIRs are associated with investee overinvestment. Prior studies have found that financial derivatives are important tools for risk management, reducing cost of capital and preventing underinvestment. This study extends these works and further examines whether the relationship between FDIRs and overinvestment is moderated by the use of hedging derivatives. Empirical results show that the proportion of FDIRs is negatively associated to firm overinvestment, suggesting that FDIRs improve the monitoring and/or advising functions of firm investment activities. A further test reveals that this negative relationship is pronounced for firms that are not engaged in derivative hedging activities. This implies that FDIRs are likely to incorporate managerial hedging programs into their monitoring and/or advising functions when examining firm investment decisions, thereby restraining overinvestment in firms that are not engaged in derivative hedging. Collectively, this study provides evidence that, in emerging markets like Taiwan, FDIRs tend to inhibit overinvestment, and this behavior is actually moderated by firm hedging derivatives activity.