Wharton/CIBC World Markets 1998 Survey of Financial Risk Management by U.S. Non-Financial Firms

Financial Management
Vol. 27, No. 4, 1998.

EXECUTIVE SUMMARY

This is the third in a series of surveys on financial risk management practice and derivatives use by non-financial corporations in the United States undertaken by the Weiss Center for International Financial Research of the Wharton School. This 1998 survey, written in partnership again with CIBC World Markets, extends the previous two surveys by asking new questions about certain aspects of derivative use and risk management practice. Among the key findings are the following:

(1) There is no evidence that the number of firms using derivatives has declined over time (as a result of well-publicized derivative losses at Proctor & Gamble and other firms). Among firms participating in one or more of our previous surveys, derivative use is unchanged. 42 % of the firms using derivatives report that their usage has actually increased as opposed to 13 % who report that their usage has decreased.

(2) As in past surveys, the use of derivatives is much higher among large firms (83 %) than small firms (12 %), and higher among primary product firms (68 %), and manufacturers (48 %) than among firms in the service industry (42 %). But use of derivatives by service firms is increasing significantly.

(3) A surprisingly large percentage of firms (73 %) report that FASB's new rule governing derivatives activity has no effect on their derivative use or risk management strategy.

(4) A new question about revenue and expense exposure in foreign currency reveals a wide range of exposure across firms. For example, 40 % of the firms with foreign exchange exposure report that their revenues in foreign currency are 20 % or more of total revenues, and almost as large a percentage report foreign currency expenses to be 20 % or more of their total expenses. On the other hand, 60 % of the firms report that they have a balance between total foreign currency revenues and expenses (though this may not true for revenues and expenses in each currency).

(5) Among firms with significant foreign exchange exposure that regularly hedge, there seems to be a general tendency to hedge only a fraction of the total foreign currency exposure of the firm. In the case of payables and receivables, for example, less than 50 % of the exposure is hedged.
The majority of hedges, moreover, are short-dated. 82 % of firms use foreign currency derivatives with a maturity of 90 days or less.

(6) A wider variety of options has become available in the last few years, but firms continue to use standard European-style or American-style options much more than such exotic options as basket or barrier options.

(7) There are several results in the survey which raise troubling issues about risk management practices among at least some of the firms. First, when asked which best describes the motivation behind their risk management activities, 40 % of the firms chose increased profit relative to a benchmark or absolute profit rather than reduced volatility. Second, 32 % of firms that use derivatives reported that their market view of exchange rates leads them to "actively take positions" at least occasionally. A similar result is found for the market view of interest rates.

(8) On the other hand, most firms seem to have internal controls over derivative use. A reassuringly large percentage of respondents, 86 %, have either a written policy about the use of derivatives or a regular schedule for reporting derivative use to the firm's board of directors.

(9) Firms are concerned about counterparty risk, especially when longer-dated derivatives are concerned. 40 % of the firms using derivatives insist on a credit rating of AA or better for their counterparty, an insistence which precludes derivative transactions with many U.S. banks.