Prospect theory: an explanation for the puzzling effect of hedging on firm value Online publication date: Wed, 17-Apr-2024
by Priyanka Mohanty; Dushyant Mahadik
International Journal of Critical Accounting (IJCA), Vol. 13, No. 4, 2023
Abstract: This paper investigates theoretically and empirically the impact of the famous behavioural theory 'The prospect theory' to explain the hedging activities of firms. We seek answers to the puzzling effect of hedging on firm value through prospect theory explanations. We suggest the influence of some reference point on the hedging habits of firms and the association between hedging and firm value. Our empirical analysis confirms the impact of prospect theory on the hedging activities of firms. We find the risk-averse attitude of managers when they are in the more profitable/gain domain, while a risk-seeking perspective is when they are in the less profitable/loss domain. We empirically focused on all the listed Indian non-financial companies (3,791) during the period 2016-2022 and confirmed the above-specified objective. This is one of the first studies to empirically examine the integration of behavioural theory and hedging by using a separate yearly industry-wise return average as a reference point.
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