Edinburgh Napier University

  The main aim of this research is to propose a new perspective to explain the usage of financial derivatives by establishing the connection between a firm’s risk management capability (i.e., a combined power behind a variety of corporate attributes towards risk and risk management) and corporate behaviours towards the use of financial derivatives. Corporate risk management is key to a firm’s survival. The use of financial derivatives as tools to manage risk has been well documented in the literature, however, the relationship between a firm’s risk management capability and the use of financial derivatives has not been investigated. In this study, a firm’s risk management capability, a relatively new concept, is defined as the ability or power of a business organisation to reduce, adapt to or mitigate risks (impacts and likelihood of a disaster) to levels that are acceptable for the organisation and its management objective, which is embedded in the organisation’s structure, relationship, organisation and corporate governance. This thesis has four research objectives, including: 1) To understand the importance of derivatives for corporations and practices of corporate usage of financial derivatives; 2) To understand the current developments of accounting, finance and risk management issues relating to derivatives; 3)To conduct case studies with a view to establishing the connection between a company’s risk management capability and the use of financial derivatives; 4) To discuss the implications of research findings for corporate managers and policy makers as regards derivatives and the use of financial derivatives.
This thesis adopts qualitative methodology because of the multifaceted and complex nature of the usage of financial derivatives. Qualitative research provides a more realistic feel of the real world and offers flexible ways of collecting, analysing and interpreting data of the phenomenon under investigation. Corporate risk management behaviour and decisions on the use of derivatives are better served by qualitative research as it is well suited to studying complex interconnections and relationships without reducing the complexity to simple numbers or variables. More specifically, this study chooses case study and content analysis as research methods. In this study, multiple-case design is adopted, including Diageo, Unilever, Intertek Group, Vodafone, Ashtead, and Merlin Entertainments. This study uses the explanatory case study method by investigating the corporate financial information from the annual reports and other documents to establish the association between a firm’s risk management capability and the use of financial derivatives. This study combines two main measures (i.e., corporate governance and CSR ratings) that can signal a firm’s risk management capability to select the six cases at different levels of risk management capability. This study has also used content analysis technique in collecting qualitative data and evidence. Content analysis is widely considered the most popular method for qualitative research and is regarded as an effective approach in an exploratory research.
The case studies show that the use of financial derivatives is linking with a firm’s risk management capabilities. Top-rated firms in risk management capability used all types of derivatives to manage their financial and operational risk, while low-rated firms used few or no derivatives and provide little details on the use of financial derivatives. The main findings include: 1) Derivatives are very important tools for firms to use to hedge against financial risks and most firms have used derivatives for hedging; none of the six case firms declared to use derivatives for speculative purposes; 2) Derivative risk management is part of corporate governance and in most cases the board of directors of firms is responsible for derivative risk management; 3) Derivatives risk management and information disclosed in the annual reports of these case firms were much different; 4) Although numerous corporate attributes influence the use of derivatives, a firm’s risk management capability that reflect the integrated power of management of the firm seems to influence the use of financial derivatives. The main implications of this study comprise: 1) Companies should improve their risk management capability by developing effective corporate governance and enhancing CSR performance; 2) Although numerous corporate attributes influence the use of derivatives, risk management capability that reflects the integrated power of management of a company, to a large extent, determines the use of derivatives; 3) Implementing risk management in a business may bring in a number of financial benefits and therefore it is necessary to have risk management as an integral part of the business’s management practice; 4) Accounting standards setters should rethink the requirement of separating the motivations of using financial derivatives between hedging and speculative purposes.