MANAGERIAL INCENTIVES AND THE USE OF FOREIGN-EXCHANGE DERIVATIVES BY BANKS

We examine the effect of managerial compensation and ownership on the use of foreign-exchange derivatives by U.S. bank holding companies. We focus on derivatives used for purposes other than trading to investigate derivative use in a hedging framework. We use instrumental variables probit and sample-selection models to estimate the effects of endogenous and exogenous factors on the probability and extent of foreign-exchange derivatives used. We find that the use of derivatives is inversely related to option awards but positively related to managerial ownership. Finally, our results suggest that ownership by large institutional shareholders provides incentive for managers to hedge. 2007 The Southern Finance Association and the Southwestern Finance Association.