Derivative hedging and performance of non-financial firms listed in the Nairobi securities exchange, Kenya.

ABSTRACT

Derivatives have been in the use by firms for the longest period. Some firms use them for trading or speculation purposes while others use them purely for hedging purposes. Despite the usage of derivatives by non-financial firms, their performance has been varying. In Kenya, listed non-financial firms use derivatives for hedging purposes while financial firms use derivatives for both speculation and hedging purposes. Contrary to the greater growth opportunities and tighter controls that make derivatives attractive, listed non-financial firms still experience variations in their market values hence posing a threat to their growth opportunities. Exchange rate fluctuations and weather uncertainty have been found to affect firms’ operations, operating cash flows and non-financial firms’ performance. Since 2010, Kenyan listed non-financial firms have made huge losses due to derivatives hedging. For example, Kenya Airways reported a net loss of Kes. 25.7 billion in 2015, out of which Kes. 7.5 billion was attributed to derivatives usage, representing 29.18 percent of the total loss reported in that financial year. This saw the firm value as measured by Tobin’s Q ratio drop from 0.08 in 2014 to 0.04 in 2015. Also, Kenol Kobil, one of the largest Oil marketers in Kenya reported a net loss of Kes. 6.28 billion for the 2012 financial year, a drop of 292 percent compared to a profit of Kshs. 3.2 billion in 2011, out of which Kes. 4.6 billion was attributed to derivatives hedging, representing a 73.25 percent of the total loss. In 2012, the firm value was 0.63 as measured by Tobin’s Q ratio. In 2013, a Tobin’s Q ratio of 0.53 was witnessed, a drop from 0.63 in 2012 even after cancelling some derivative contracts. Therefore, this study sought to find out the effect of derivatives hedging on the performance of non-financial firms listed in the Nairobi Securities Exchange as measured by the Tobin Q’s ratio. The specific objectives of the study were, to determine the effect of currency derivatives hedging, commodity derivatives hedging and interest rate derivatives hedging on the performance of non-financial firms listed in the Nairobi Securities Exchange. The study targeted all the 34 Nairobi Securities Exchange listed non-financial firms as at 31st December 2017, out of which 10 firms were sampled purposively and studied for a period of six years, i.e., 2012 – 2017. A descriptive survey research design and a positivism study philosophy were utilised in the study. The study used both primary and secondary data. Primary data was collected through a questionnaire while secondary data, which was used to evaluate the performance of the Nairobi Stock Exchange listed non-financial firms, was obtained from the published financial statements of the firms. The collected data was analysed using estimators of Stata 15. The study applied both descriptive and inferential statistics to analyse the quantitative data that was collected. The study employed panel data (Fixed effects) based on the Hausman specification outcome, to determine the effect of derivatives hedging on the performance of non-financial firms listed in the Nairobi securities exchange. A negative relationship was found between the derivatives hedging and the performance of the non-financial firms. Currency derivatives, commodity derivatives and interest rate derivative hedging were positively related to the performance of non-financial firms listed in the Nairobi Securities exchange. Exchange rates were found not to have a moderating effect on the relationship between derivatives hedging and the performance of the non-financial firms. The study therefore recommends the usage of currency derivatives for hedging purposes and a better combination of interest rate derivatives and commodity derivatives in hedging interest rates and commodity risks.