Strategic shield or financial fad? Investigating derivative use by Indian firms
Shubhangi Bedi, Keshav Malhotra, Meena SharmaPurpose
This study aims to explore the determinants of derivatives usage for nonfinancial firms in India. A fast growing developing emerging economy that is characterized by its own distinctive institutional and regulatory environment. Beyond identifying firm-level drivers, this paper contributes to the literature by simultaneously examining the association between derivative use and firm performance (Return on Assets [ROA]) and firm value (Tobin’s Q), an aspect underexplored in the Indian context. The study further documents the role of institutional ownership and governance structures in derivative adoption decisions during the post-liberalization period 2015–2022, and grounds its hypotheses explicitly in hedging (risk-management) theory and agency theory.
Design/methodology/approach
The analysis is based on a sample of 184 nonfinancial companies listed on the Bombay Stock Exchange (BSE) between 2015 and 2022 (1,472 firm-year observations). The study employs logit regression on pooled cross-sectional data, complemented by univariate tests, and descriptive statistics to examine the relationship between firm characteristics and the use of derivatives. Robustness checks include a random-effects panel logit model that exploits the full panel structure of the data, industry fixed-effects specifications, and an alternative keyword-coding protocol for the dependent variable.
Findings
The results indicate that firm size is the primary determinant of derivative use, with larger firms more likely to engage in derivative transactions owing to greater exposure to market risk and higher capacity to bear related expenses. Leverage has little effect on derivative use, while firms with higher R&D intensity tend to use derivatives less, suggesting a more complex link with potential growth opportunities. In the univariate analysis, derivative users exhibit statistically higher ROA and Tobin’s Q than nonusers; however, these performance differences do not survive multivariate controls, suggesting that size is the primary underlying driver rather than derivative usage per se. Both institutional ownership and non-debt tax shields were positively related to adoption in univariate comparisons, but only the non-debt tax shield is significant in the multivariate model with firm size and other characteristics held constant. For this sample, institutional ownership is not an independent predictor of financial contracts and derivatives.
Practical implications
The findings offer concrete guidance for multiple stakeholders. Managers of mid-sized firms approaching scale thresholds should proactively develop hedging expertise and risk management infrastructure. Investors and analysts should be cautious about attributing the higher Tobin’s Q and ROA observed among derivative users to hedging itself, since this premium does not survive controls for firm size. Policymakers, particularly the Securities and Exchange Board of India (SEBI), may consider derivative-usage intensity disclosure requirements; our multivariate results do not, however, support institutional-ownership-facilitation policies as a direct lever for derivative adoption, since this association is not robust to controlling for firm size. For small and medium-sized enterprises, barriers to derivative access remain significant, pointing to a need for regulatory support mechanisms.
Originality/value
This paper’s contribution is distinct from prior Indian derivative-usage studies in three specific respects. Unlike single-outcome studies that examine either the value and risk consequences of hedging (Chaudhry and Gupta, 2023) or the determinants of currency-specific hedging alone (Mathur and Singh, 2024), this paper: (1) provides large-sample evidence on derivative adoption determinants from India during the post-liberalization phase (2015–2022), explicitly grounded in hedging and agency theory; (2) simultaneously examines firm performance and value implications within a unified empirical framework, showing that univariate performance differences do not survive multivariate controls a distinction not drawn out in prior Indian work; and (3) documents the roles of institutional ownership and governance in derivative adoption, dimensions rarely examined jointly in the Indian emerging-market context.