Foreign Currency Exposure and Hedging: Evidence from Foreign Acquisitions

Previous research on the impact of currency risk on stock returns has failed to find a significant role for foreign exchange rates. This paper addresses several explanations of this finding with a unique dataset of U.S. firms that acquire targets in other countries. The dataset allows estimating the impact of exchange rates using firm-specific bilateral exchange rates and a time period where underlying exposure is known to exist. We also relate the change in exposure from before to after the acquisition to various characteristics of the acquirer, such as its presence in the target country prior to the deal and its hedging activities, and characteristics of the target, such as the exposure of the target prior to the deal, the relative size of the deal, and the volatility of the exchange rate of the target’s country. The results suggest that identifying a relevant exchange rate can be an important consideration in studying the impact of exchange rate risk on stock returns. Moreover, corporate hedging activities play a role, since the foreign targets provide operational hedging benefits to the U.S. acquirers. Many acquirers also use foreign currency derivatives and debt denominated in foreign currency, though the effect of financial hedging on currency exposures is found to be small for the firms in the sample