The Impact of Institutional Differences on Derivatives Usage

Abstract

This paper examines the influence of institutional differences on risk management practices in the US andthe Netherlands. This comparison is interesting because the Dutch firms' institutional setting differs fromthe US setting with respect to shareholder orientation, international trade, disclosure regulation, andreliance on financial markets. In contrast with previous comparisons, we apply a matching and weightingstrategy that corrects for differences over industry and size classes across the Dutch and US samples.After these corrections, the remaining results can be attributed more directly to institutional differences.We find that due to the greater openness of the Netherlands, Dutch firms hedge more financialrisk, especially more currency risk, than US firms. Dutch firms, however, show a lower level of concernover derivatives usage, which is consistent with having less active minority shareholders and less strictdisclosure requirements than the US has. Dutch firms focus le ss on stabilizing accounting earnings withderivatives than US firms, which is likely attributable to the strong shareholder orientation in the USversus the stakeholder orientation in the Netherlands. Whereas Dutch firms tend to rely almostexclusively on OTC-transactions, US firms use exchange-traded derivatives and more counter-parties.This results in US firms imposing stricter requirements on counter-party rating for derivativestransactions. This distinction can be attributed to the differences in the financial environments betweenthe US and the Netherlands. These, and other results, strongly suggest that institutional differencesbetween the US and the Netherlands have an important impact on risk management practices andderivatives use across US and Dutch firms.hedging;risk management;derivatives;international finance