Linking Country Governance Quality and Derivatives Use: Insights from Firms’ Hedging Behavior in East Asia

Abstract:This paper examines the link between countries’ governance quality and firms’ use of derivatives using a novel hand-collected dataset. Our panel data includes 881 non-financial firms across eight East Asian countries. We found that better country governance induces firms to use derivatives to hedge exposure and mitigate costs. Firms in countries with weak governance use derivatives for speculative and/or selective hedging or self-management purposes. Overall, our findings provide strong evidence of the role of countries’ governance quality in driving firms’ derivatives-related behaviors. This macro-based effect on derivatives use is independent of firm-specific factors, which are frequently invoked by hedging theories.