4 Ways To Battle Selective Hedging For Strong Corporate Governance

Are narcissistic managers steering your company's financial ship into treacherous waters? In this article, we delve into the nuanced relationship between corporate governance, narcissistic managers, and the perilous practice of selective hedging.

You will learn four key strategies that will help you improve your corporate governance and avoid engaging in selective hedging that may put the future of your company at risk.

And if you want to learn more about selective hedging, check out this episode of CurrencyCast where our Senior Financial Writer explains the topic.

The Dangers of Weak Corporate Governance

Corporate governance is the system by which companies are directed and controlled. It is formed by a Board of directors that are in charge of the governance of the company to help build trust with the investors and the different stakeholders. Their main role is to appoint the directors and auditors, and to ensure that an appropriate governance structure is in place.

Strong corporate governance gives investors and stakeholders a clear idea of a company's direction and business integrity. Moreover, it promotes long-term financial viability, to keep the company afloat even in volatile times. But empirical studies consistently reveal a disturbing trend.

Companies with weak corporate governance standards are more likely to indulge in speculative unsystematic hedging, commonly known as selective hedging. This hazardous approach, driven by the whims of managers rather than sound financial principles, poses a significant threat to the future stability of the company.

Decoding Selective Hedging

Selective hedging takes place when a company hedges its exposure opportunistically, aligning with managers' views on currency markets. This practice rests on two pillars: attempting to beat the market based on managers' intuition and adjusting the size and timing of positions, leading to excessive volatility in hedge ratios.

This is particularly risky for the company, as we have seen in recent times that unprecedented events can have a great economic impact impossible to predict.

The Link Between Governance and Selective Hedging

Studies indicate a strong correlation between weak corporate governance structures and the inclination to engage in selective hedging. A key metric for governance quality is the percentage of independent directors within the Board of Directors, acting as a vital check on managerial discretion.

Unmasking Reluctance To Hedge

Companies with weak governance structures may be hesitant to hedge currency exposure for two primary reasons: optimism about favourable market movements or reluctance in the face of unfavourable interest rate differentials. Such firms afford managers greater discretion over hedging policies, making them less accountable.

Narcissism In The Equation

Enter the realm of narcissistic managers, individuals more prone to risk-taking and questionable behaviour. Researchers have employed natural language processing to identify narcissistic traits in managers, revealing a strong correlation between narcissism and selective hedging practices.

Strengthening Corporate Governance in Forex Hedging

To help you avoid the dangerous practice of unsystematic hedging, here are four actionable steps to enhance corporate governance in foreign exchange hedging:

1. Implement controls at each FX workflow phase: Ensure oversight in the pre-trade, trade, and post-trade phases to mitigate the risk of selective hedging.
2. Utilise automated conditional orders: When facing unfavourable forward points, consider employing automated conditional orders to delay hedge execution, reducing the cost of carry while actively managing exposures.
3. Adopt market-driven programs: Shift from time-based FX hedging programs to automated market-driven programs, facilitating scalability across currency pairs and avoiding unhedged exposures.
4. Enhance FX centralisation: Increase the degree of FX centralisation to prevent silos within the organisation, curbing the use of foreign exchange derivatives in subsidiaries with weaker governance structures.

Conclusion

As financial stewards, CFOs and Treasurers must recognise the critical link between corporate governance, narcissism, and selective hedging. By implementing these four steps, companies can fortify their governance structures, safeguarding against the pitfalls of selective hedging and steering towards a more resilient financial future.

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