Hedging, Financing, and Investment Decisions : A Theory and Empirical Tests

In this paper we theoretically and empirically examine the interaction between hedging, financing, and investment decisions. A simple equilibrium model with costly financial distress suggests that as firms become more efficient at risky investments vis a vis riskless investments, they will borrow less, invest more in risky assets, and hedge more. The model also predicts a positive relationship between hedging and leverage, which is consistent with debt capacity arguments. Using Probit, OLS and simultaneous equations, we find that the empirical findings are for the most part consistent with the model predictions