Ownership structure, corporate derivative use, and analyst forecasts: evidence from China

Corporate derivative use has attracted significant attention from researchers, regulators, and financial statement users as a result of its increasing role in risk management and potential damage to firm value. The existence of manager-shareholder agency conflict and the consistent efforts of regulators create opportunities for research into the determinants of derivative use efficiency. Meanwhile, the various effects of derivative use raise another question on how it impacts the decisions of financial statement users. Therefore, this thesis contains the following three aspects. Firstly, using hand-collected derivative use data on publicly listed firms in China, this thesis documents that derivative use has a significant risk-reducing effect but that this effect is 40% weaker in state-owned enterprises (SOEs) than in non-SOEs. This thesis also finds that soft budget constraints and information transmission inefficiency are two mechanisms through which state ownership impedes this risk reduction. Firstly, financial distress reduces the impact of the soft budget constraints, mitigating the weaker risk-reducing effect of state control. Secondly, the risk-reducing effect of derivative use is weaker in local SOEs than in central SOEs, as the former are subject to more information friction than the latter. These findings provide new information and insight into risk management effectiveness from the perspective of ownership identity. Secondly, this thesis explores the role of non-controlling government shareholdings in the enforcement of derivative-related regulations that aim at improving corporate risk-management behaviour. This thesis finds that a non-controlling government shareholder with a higher hierarchical level relative to the controlling shareholder (a higher-level government shareholder) improves the risk reducing effect of derivative use. The impact of a higher-level government shareholder increases with its closeness to the rule maker (i.e., the central government) and its access to corporate information, suggesting that higher-level government shareholders have information and knowledge advantage of derivative-related regulations. Using exogenous top-down regulations that disciplined SOEs’ derivative use around 2010, this thesis identifies an increased impact of a higher-level government shareholder on the risk-reducing effect of derivative use after 2010, confirming the role of a higher-level government shareholder in ensuring derivative-related regulations achieved their objectives. Overall, these findings suggest that higher-level government shareholders play an important role in disciplining derivative use and that their presence can effectively improve regulatory enforceability. Finally, this thesis concentrates on derivative use and analyst behaviours in China, a representative of emerging markets and relationship-based economies, and examines whether corporate derivative use is useful to analyst forecasts. This thesis finds a negative relationship between corporate derivative use and the error and dispersion of analyst forecasts. This relationship is stronger in firms with greater uncertainty, for analysts without social networks with firms, and in well-governed firms. Consistent with the main findings, this thesis finds an increase in analyst following in the year of derivative initiation, and this increase lasts for one year after derivative initiation. In addition to complementing existing studies on the relationship between derivative use and analyst behaviours by exploring the heterogeneity in firms’ and analysts’ characteristics, this evidence highlights the importance of institutional features in explaining the consequences of derivative use.