Financial Hedging and Operational Flexibility as Instruments to Manage Exchange-rate Uncertainty in Multinational Corporations

Literature that compares the advantages of financial hedging and operational flexibility as instruments to manage exchange-rate uncertainty presents inconsistent results. This study addresses such inconsistencies in two ways. First, it clarifies that the effects of financial hedging and operational flexibility are asymmetric. Financial hedging helps an MNC to reduce a negative effect of exchange-rate uncertainty on firm value, whereas operational flexibility allows an MNC to enhance a positive effect of exchange-rate uncertainty on firm value. Second, the study demonstrates that these effects are contextual to the MNC's subsidiary network. Depending on whether exchange-rate correlation in the subsidiary network is positive or negative, either financial hedging or operational flexibility is more effective than the other. Regressions on a sample of U.S. manufacturing firms support the predictions.