ABSTRACT
The study examined the effect of hedge accounting on the financial performance of listed deposit money banks in Nigeria. The specific objectives of the study were; to examine the effect of hedge accounting (derivative asset and derivative liability) on the return on asset of listed commercial banks in Nigeria, to determine the effect of hedge accounting (derivative asset and derivative liability) on the return on equity of listed commercial banks in Nigeria, to examine the effect of hedge accounting (derivative asset and derivative liability) on earnings per share of listed commercial banks in Nigeria and to ascertain the effect of hedge accounting (derivative asset and derivative liability) on profit after tax of listed commercial banks in Nigeria. To achieve the objectives of the study the ex-post facto research design was adopted. For this study, secondary data was used through the use of annual reports and accounts of the selected commercial banks. The population of the study was made up of 14 listed commercial banks as at December 2020 while the sample size was 10 selected banks. Data was analyzed using panel data regression analysis. The finding revealed that (i) Hedge accounting (derivative asset and derivative liability) has no significant effect on the return on asset of listed commercial banks in Nigeria, (ii) Hedge accounting (derivative asset and derivative liability) has a significant effect on the return on equity of listed commercial banks in Nigeria, (iii)Hedge accounting (derivative asset and derivative liability) has no significant effect on earnings per share of listed commercial banks in Nigeriaand (iv)Hedge accounting (derivative asset and derivative liability) has a significant effect on profit after tax of listed commercial banks in Nigeria. Based on the findings, the study recommended that banks should improve on accounting for hedging through derivative by fully adopting the prescription made by IFRS 7 and 9, this will give confidence to intending investors and in turn increase the return on asset of banks in Nigeria. Also, more funds should be committed to the use of derivatives for hedging against interest rate fluctuations that possibly affects the earnings of the banks.
TABLE OF CONTENTS
Title Page i
Declaration page ii
Certification iii
Dedication iv
Acknowledgement v
Table of content vi
Abstract x
CHAPTER 1: INTRODUCTION
1.1 Background to the Study 1
1.2 Statement of the Problem 4
1.3 Objectives of the Study 6
1.4
Research Questions 7
1.5
Research Hypotheses 7
1.6
Significance of the Study 8
1.7 Scope of the Study 9
1.8 Limitations
of the Study 9
1.9 Operational
Definition of Terms 9
CHAPTER 2: REVIEW OF RELATED
LITERATURE
2.1 Conceptual Framework 11
2.1.1 Concept of hedging 11
2.1.2 Benefits of hedge accounting 13
2.1.3 Hedging techniques 15
2.1.4 Hedging strategies 18
2.1.5
Concept of derivative accounting 19
2.1.5.1 Uses of derivatives 25
2.1.6 Dealing
with problems of derivatives valuation 31
2.1.7 Accounting
of derivatives 32
2.1.7.1 Accounting
for derivative under SFAS (161) 32
2.1.7.2 Accounting
for derivatives under IFRS 9 34
2.1.8 Concept of firm
performance 37
2.1.9 The relationship between
hedging strategies and financial performance of firms 38
2.1.10 Determinants of firm performance 39
2.2 Theoretical Framework 40
2.2.1 Optimal hedging theory
41
2.2.2 Manager’s personal
utility maximization theory. 41
2.2.3 The purchasing power parity
theory 42
2.2.4 The international fisher
effect 42
2.3 Empirical Review 43
2.4 Summary of Literature Review 61
2.5 Gap in Literature 62
CHAPTER 3: METHODOLOGY
3.1
Research Design 63
3.2 Area of the Study 63
3.3
Population of the Study 63
3.4 Sample and Sample Size Determination 63
3.5 Method of data Collection and Data Sources 64
3.6 Data analysis Technique 64
3.7 Model Specification 65
3.8 Description of the Variables of the Study: 65
CHAPTER 4: DATA PRESENTATION,
ANALYSIS AND DISCUSSION OF FINDINGS
4.1 Data Presentation 67
4.2
Pre-estimation Tests 67
4.2.1
Stationarity/ unit root tests 67
4.2.2 Cointegration test results 68
4.3 Data Analysis 72
4.3.1 Hausman test for hypothesis one 72
4.3.2 Panel data test 73
4.3.3 Hausman test for hypothesis two 74
4.3.4 Data analysis for hypothesis two 75
4.3.5 Hausman test for hypothesis three 76
4.3.7 Data analysis for hypothesis three 77
4.3.5 Hausman test for hypothesis four 79
4.3.7 Data analysis for hypothesis four 80
4.4 Discussion on Results 81
CHAPTER 5: SUMMARY OF FINDINGS, CONCLUSION
AND RECOMMENDATIONS
5.1 Summary
of Findings 84
5.2
Conclusion 84
5.3
Recommendations 85
5.4 Contribution
to Knowledge 86
5.5
Area of Further Research 86
References 87
Appendices 98
LIST OF TABLES
4.1. Augmented
Dickey Fuller (ADF) Test 67
4.2: Table for
co-integration test 68
4.3 Descriptive statistics 69
4.4: Hausman result for hypothesis one 72
4.5: Regression Result for hypothesis one 73
4.6: Hausman result for hypothesis two 74
4.7: Regression Result for hypothesis two 75
4.8: Hausman result for hypothesis three 76
4.9: Regression Result for hypothesis three 77
4.10: Hausman result for
hypothesis four 79
4.11:
Regression Result for hypothesis four 80
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Risk
management is an important component of financial management of organizations
especially those involved in international trade because of their exposure to
foreign currency price fluctuations. This follows high volatility in the
foreign exchange market thereby creating uncertainty. The inherent forex risks
lead to adverse exchange rates fluctuations that may result into organizational
losses where foreign currencies are involved. Barney (2001) opines that forex
risks are risks that are attributed to unexpected exchange rates changes and
overall foreign exchange exposure. Companies are exposed to this risk if their
project results actually depend on future exchange rates especially where
future exchange rate changes are difficult to anticipate. Forex risk management
entails adopting assessment programs that are meant to readily identify as well
as quantify forex risks so as to counteract and mitigate the identified forex
risks hence salvaging economic value of firms (Giddy, 2010).
Financial
risk management has therefore become one of the most important business
strategies of firms. Firms that do not adapt financial risk management
strategies are likely to witness poor growth patterns compared to those that
adapt financial risk management strategies. There exist several financial risk
management strategies that may be used to reduce the financial risks such as
portfolio diversification for diversifiable risks and hedging practices for
non-diversifiable risks. (Sharpe, Alexander & Bailey, 2013)
The
operating environment for businesses has become very volatile following
increased globalization and internationalization of firms. Together with this,
the business environment in Nigeria has witnessed high variation in the foreign
exchange rate over the recent past as the Nigeria Naira depreciates against the
widely used United States Dollar. Since majority of the firms either source
their inputs or sale their output internationally, they have been affected by
the fluctuation in exchange rates calling on them to implement necessary
measures to manage the foreign exchange risk.
Therefore, the need for entities or
investors to consider hedging activities arises in order to minimize the damage
caused by the risks for the entities and investors. Firms employ the use of
derivative financial instruments to hedge exposure to various risks. In the
corporate world, the economic environments that business organizations operate
in have over time grown more complex (Mbungu, 2013).
Hedging
has conventionally been defined as a tactic for reducing the risk in upholding
a market position while speculation refers to taking a position in the way the
markets would shift. Nowadays, hedging and speculation strategies, together
with derivatives, are versatile tools or methods that enable companies to
administer risk more efficiently. A range of hedging techniques is accessible
for managing currency risk. These methods may be classified under two clusters:
internal techniques are those that are meant at reducing or averting an exposed
position from occurring and external techniques are usually contractual
measures expected to minimize exchange losses that may arise from an existing
exposure (Giddy & Dufey, 2012).
Hedging
is one of the risk mitigating strategies that is commonly used by firms.
Hedging reduces the risk of future price movements which might affect a firm
adversely if not well managed (Horne & Wachowicz, 2012). Hedging is done by
a firm or individual to protect against a price change that would otherwise
negatively affect profits (Brigham & Ehrhardt, 2014). It provides
relatively inexpensive and highly liquid positions similar to those obtained
with diversified stock portfolios (Sharpe, Alexander & Bailey, 2013). To
hedge a firm can use a wide range of financial instruments, including forward
agreements, futures contracts, options or swaps, to achieve their hedging
goals. Bartram, Brown & Conrad (2011) on a survey of firms from 47
countries found out that the use of these instruments reduced firm’s total risk
and is more experienced in firms with higher exposures to interest rate risks,
exchange rate risks and commodity prices risks. In United States, 83% of
hedging firms use forward agreements, futures contracts, options or swaps to
hedge foreign exchange risk, 76% use them to hedge interest rate risk and 56%
use them to hedge commodity price risk (Bodnar & Wong, 2000). Therefore it
follows that forward agreements, futures contracts, options and swaps are
commonly used in hedging interest rate risks, foreign exchange risks, and
commodity price risks.
The
choice of exchange risk hedging techniques can be influenced by a number of
factors, namely; size, amount of research and development expenditure, exposure
to exchange rates through foreign sales and foreign trade, liquidity of the
firm, ownership structure among others (Allayanis & Ofek, 2001). Large
companies are expected to have significant exposure to foreign exchange risk
and it is believed that companies aggressively manage the risk (Bodnar&
Wong, 2000). Smith and Stulz (2005) found that larger firms that are dependent
on export revenue have lower exposure to exchange rate risk.
Financial
performance refers to the extent to which financial objectives of a firm are
being met. Different methods, including stock market based and accounting based
ones, are used to measure financial performance. Return on total assets (ROA)
is the widely used accounting measure. It indicates the management’s ability to
convert assets into net earnings. The higher the ROA the better the
performance. There are other measures of financial performance which includes profit
margin, return on equity, dividend per share and earnings per share among
others (Li, Visaltanachoti & Luo 2014).
Exchange
rate fluctuations affect the value of firms differently from the share prices
and return on investments by shareholders (Gutierrez, 2013). Movement in
general exchange rate affects the reporting of financial statements for firms
operating in multiple markets as they convert one currency transactions into
another for the purpose of financial statement preparation. However, in order
to minimize the effect of general changes in foreign currency prices, companies
cushion themselves through adoption of several mechanisms. These actions are
aimed at minimizing the exposure thus improving the overall financial returns
on investment.
Rutagi
(2017), established that changes in the cost of different currencies directly
affect the prevailing prices of commodities on the domestic market hence the
overall firm profitability. It also affects the volume of goods transacted as
it influences the purchasing power of consumers. According to a study conducted
by Gachua (2011), foreign exchange rate exposure affects the overall financial
returns recorded by organizations. These risks arise whenever an organization
has cash obligations and assets to be collected in future (Mweni, 2014).Mbire and Atingi, (2017) stated that most of the
international firms utilize various hedging or arbitrage strategies to
stabilize financial earnings or firm value especially when there are obvious inconsistencies
in global exchange movements. Management of risk effectively leads to
profitability of businesses (Mweni, 2014). Firms often make
use of a micro hedging strategy to manage their interest rate risk exposure of
a portfolio financial assets and liabilities. Hence the need to study the
effect of hedge accounting on financial performance of listed commercial banks
becomes necessary.
1.2 STATEMENT OF
THE PROBLEM
There
is no country that is self-reliant as it has to import and export some
products. Vong and Hoi (2009) assert that firms engaged in business across
national boundaries are exposed to risks arising from general changes in the
cost of different currencies because of its effect on the payables and
receivables denominated in foreign currencies. In order to cover their
exposure, firms apply different instruments like SWAPs, forwards, options, and
holding foreign currency denominated rates among others.
Commercial
banks listed at the Nigeria Stock Exchange have faced various forex challenges
following unstable exchange rates which saw the Kenyan currency depreciate
against major currencies. Unstable forex saw some of the firms record huge
losses as they imported some of their inputs and exported some of their outputs.
This meant that in order to protect their exposure, they needed to implement
various forex exposure management strategies.
In
late 2008, international markets were grossly affected by a sharp and
unexpected spike in foreign exchange instability. The global financial crisis
caused many firms to revert to existing risk management strategies or formulate
new ones. The use of foreign currency derivatives was being reassessed by
companies trying to efficiently manage the exaggerated raise in currency risk
associated to the global financial crisis (Kirschner, 2009). The Nigeria security market in regard to
spurring new financial innovations remains relatively poor despite being regarded
as one of the best in Africa (Mwangi, 2001) The Nigeria economy is becoming
more and more open with international trading constantly increasing and as a
result Nigeria firms become more exposed to foreign exchange rate fluctuations.
The relative price changes affect the firms’ competitive market position,
leading to changes in cash flows and ultimately, in firms performance (Noor
& Abdalla, 2014).
Various
studies on hedge accounting and firm performance have reported mixed findings.
On international level, Ahmed, Azevedo and Guney (2014) looked at how the value
of firms was affected by different hedging strategies using non-financial firms
from the UK. According to another study conducted by Ahmed, Azevedo and Guney
(2014) application of hedge accounting help financial institutions manage their
position and hence improve overall financial results. The study was conducted
among commercial banks with mixing results. Mbungu (2013) established that
foreign exchange risk management promoted better overall financial results of
exporting firms because it enables them improve on financial results.
Further,
Gachua (2011) examined how a firm’s exposure to changes in prices of foreign
currency affect an organization’s overall financial results using a case of
listed companies. The finding showed
that firms were negatively affected by changes in the foreign currency prices. Makau
(2008) examined the responsiveness of Kenya’s financial institutions securities
to the changes in the cost of lending and cost of foreign currency over a
period of ten years (2001-2010). Elahi and Dehashti (2011) surveyed how
fluctuations in currency prices affect tea exports using the case of
smallholders’ tea factories in Nigeria and established that it led to
uncertainty in the general earnings.
From
the above review, the existing studies were either done in other economies
which limit their application in Nigeria. To fill in the existing gap, this
study was carried out in the banking sector. It is against this backdrop that
this study intends to examine the effect of hedge accounting on the financial performance
of listed commercial banks in Nigeria.
1.3 OBJECTIVES OF THE STUDY
The
main objective of the study is to examine the effect ofhedge accounting on the financial
performance of listed commercial banks in Nigeria. Other specific objectives
include:
(i)
To examine the effect of hedge accounting on the return on
asset of listed commercial banks in Nigeria.
(ii)
To determine the effect of hedge accounting on the return on
equity of listed commercial banks in Nigeria.
(iii)
To examine the effect of hedge accounting on earnings per
share of listed commercial banks in Nigeria.
(iv)
To ascertain the effect of hedge accounting on profit after
tax of listed commercial banks in Nigeria.
1.4 RESEARCH QUESTIONS
The following
questions guided the study
(i)
What is the effect of hedge accounting on the return on asset
of listed commercial banks in Nigeria?
(ii)
What is the effect of hedge accounting on the return on
equity of listed commercial banks in Nigeria?
(iii)
What is the effect of hedge accounting on earnings per share of
listed commercial banks in Nigeria?
(iv)
How does hedge accounting affect profit after tax of listed commercial
banks in Nigeria?
1.5 RESEARCH HYPOTHESES
For the purpose
of the study, the following stated null hypotheses were tested.
H01: Hedge accounting has no
significant effect on the return on asset of listed commercial banks in
Nigeria.
H02: Hedge accounting has no
significant effect on the return on equity of listed commercial banks in
Nigeria.
H03: Hedge accounting has no
significant effect on the earnings per share of listed commercial banks in
Nigeria.
H04: Hedge accounting has no
significant effect on profit after tax of listed commercial banks in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
This
study would be of significance to managers in organizations, scholars and investors.
To
managers in corporate organizations, the findings would be important in
informing their foreign exchange risk management strategies because they would
be in a position to link the strategies to the exposure of fluctuations in the
general prices of foreign currency of the firms especially multinational
corporations and those firms involved in international trade. By applying the
findings, managers would be in a better position to anticipate and plan
corrective measures when faced with foreign exchange risk exposure. The
findings will also enlighten managers on the effect of hedge accounting on
financial performance of firms especially those listed in Nigeria stock
exchange.
The
findings of this study will be significance to investors. Investors need to
know the performance level of every firm before making investment decision.
Risk exposure is one of the major factors that hinder firms’ performance.
Hence, application of hedge accounting helps to mitigate against these risks.
The study will enlighten investors on the importance of hedge accounting as
well as its application in corporate organization. Such will give investors’
confidence to invest in a particular firm.
To
scholars and academicians, the study would add to the existing literature on
foreign exchange risk hedging strategies and its application. This would
broaden their comprehension of the theories on the subject of foreign exchange
risk hedging besides suggesting areas for further research. Consequently, the study will serve as a
reference material to scholars who would want to carry out a similar topic in
future.
1.7 SCOPE OF THE STUDY
The
study investigated the effect of hedge accounting on the financial performance
of listed commercial banks in Nigeria for the period of ten years ranging from
2011to 2020. The period is used because of the recent fluctuation in exchange
market which can lead to bank failures. With hedge accounting, such risk can be
managed.
1.10
LIMITATIONS OF
THE STUDY
Although this study is scientifically carried out, there are
potential limitations of the study that should be taken into consideration. The
current research is restricted only to the listed deposit money banks.
Furthermore, this research is conducted based on secondary data collection. The
other data collection method such as survey is not considered. As a result the
data collected is not 100% accurate as it only captured quantifiable data
neglecting the expression and views of firm managers on how they use hedging
strategies other than derivatives to improve the value of the banks. In
addition to these, data representing the period of 2011 to 2020 is used for the
study. Thus, current issues and causation cannot be inferred.
1.11
OPERATIONAL
DEFINITION OF TERMS
Hedge accounting: This is a special
accounting treatment that enables a company to dampen earnings volatility
resulting from mark-to-market accounting.
Derivative asset: This represents the reported
figure of derivative asset in the financial statement of the banks. The figure
reported represents the computation of derivative instrument classified as
assets by the banks in line with IFRS 9 in a given year.
Derivative liability: This represents the reported
derivative liability in the financial statement of the banks. The figure
reported represents the computation of derivative instrument classified as
liability by the banks in line with IFRS 9 in a given year.
Performance:
Performance is completion of a task with application of knowledge, skills and
abilities. In work place, performance or job performance means good ranking
with the hypothesized conception of requirements of a task role, whereas
citizenship performance means a set of individual activity/contribution that supports
the organizational culture.
Earnings per share: This variable is used to
measure the market value of the banks. It is derived from the net income after the
income statement has been prepared.
Earnings per share are calculated by dividing the net profit or loss of
the period attributable to shareholders by the weighted average number of
ordinary shares outstanding. In this study it is gotten by taking the figures
of the banks reported earnings per share in their financial statement that
represents the proportion of total income to total outstanding shares of the
firm at a time.
Net profit margin: This is the percentage of revenue left after all expenses have been
deducted from sales. The measurement reveals the amount of profit that a
business can extract from its total sales. The net sales
part of the equation is gross sales
minus all sales deductions, such as sales
allowances. The formula is: (Net profits ÷ Net sales) x 100 = Net
profit margin.
Return on asset: Return on Assets (ROA) is an
indicator of how profitable a company is relative to its total assets. ROA
gives an idea as to how efficient management is at using its assets to generate
earnings. Calculated by dividing a company's annual earnings by its total
assets, ROA is displayed as a percentage.
Return on equity: Return on equity (ROE) is
the amount of net income returned as a percentage of
shareholders equity. Return on equity measures a corporation's
profitability by revealing how much profit a company generates with the money
shareholders have invested.
Click “DOWNLOAD NOW” below to get the complete Projects
FOR QUICK HELP CHAT WITH US NOW!
+(234) 0814 780 1594
Login To Comment