Companies Struggle To Manage Currency Risks Study Shows That Two-Thirds Of Corporations Do Nothing
How does a U.S. corporation doing business abroad keep from being swept away by fast-moving currencies - plummeting pesos, falling dollars, ascending yen?
Many corporations employ devices - ranging from forward contracts that lock in foreign currency values in advance at a fixed rate to more complex derivative investments - but a surprising number of firms do nothing, according to a study by two Wharton School economists. They found that only about a third of 530 randomly selected non-financial corporations used financial instruments to protect against currency changes.
Larger firms were more likely than small ones to use derivatives to hedge against currency fluctuations, and companies involved in agriculture and mining were more likely than manufacturing firms to use them, said Richard Marston, a professor of finance who heads the Weiss Center, Wharton’s international financial research center.
Mobil Corp. takes an aggressive approach to currency risks, operating an internal bank that coordinates corporate currency transactions. The bank, about two-and-a-half years old, “collects foreign currency exposures from all the affiliates worldwide and puts into place any hedging strategy,” said Joanne Hogan, the oil company’s manager of foreign exchange.
The centralized organization frees operations managers from worrying about currency risks. Line operators report currency “mismatches” to the bank, which tries to offset them. For instance, if an affiliate is receiving income in dollars but has to pay expenses in yen, that’s a mismatch.
The bank provides strategies to protect the affiliate if the dollar plummets - as it has recently, making it more expensive to buy the yen it needs. The aim of the bank is to keep operations currency neutral, she said.
Black & Decker Corp. also is moving toward a centralized system for hedging currency risks, said Mark Rothleitner, assistant treasurer of international finance and treasury. But the power tool and appliance maker will leave some decisions about whether to hedge to operations managers.
Once the decision is made, employees in the central organization look at other currency positions within the company to see if they offer offsets. Then the currency specialists will calculate and try to hedge the company’s net currency risk, Rothleitner said.
Colgate-Palmolive Co. said it generally avoids currency risks by producing products in the countries where they are sold. “We have sort of a built-in hedge from an operating point of view, and the fact that we do business in so many countries provides us with another sort of hedge,” said Brian Heidtke, corporate treasurer and vice president.
However, the company does guard against currency fluctuations that might reduce the value of cash payments received as royalties for its trademarks and dividends from affiliates, he said. The consumer products company buys forward contracts that fix the value received for those payments. The company buys those contracts on a rolling basis over time, he said, so “we don’t hit the market at any one time, when the market is good or when the market is bad.”
Spectacular losses of Orange County, Calif., Barings PLC and others may discourage companies from using derivatives to control currency risks, said Marston.
“You have to be very careful who’s using them and keep very tight control,” he said.