The Impact of Institutional Differences on Derivatives Usage

This paper examines the influence of institutional differences on risk management practices in the US and the Netherlands. This comparison is interesting because the Dutch firms' institutional setting differs from the US setting with respect to shareholder orientation, international trade, disclosure regulation, and reliance on financial markets. In contrast with previous comparisons, we apply a matching and weighting strategy that corrects for differences over industry and size classes across the Dutch and US samples. After these corrections, the remaining results can be attributed more directly to institutional differences. We find that due to the greater openness of the Netherlands, Dutch firms hedge more financial risk, especially more currency risk, than US firms. Dutch firms, however, show a lower level of concern over derivatives usage, which is consistent with having less active minority shareholders and less strict disclosure requirements than the US has. Dutch firms focus le ss on stabilizing accounting earnings with derivatives than US firms, which is likely attributable to the strong shareholder orientation in the US versus the stakeholder orientation in the Netherlands. Whereas Dutch firms tend to rely almost exclusively on OTC-transactions, US firms use exchange-traded derivatives and more counter-parties. This results in US firms imposing stricter requirements on counter-party rating for derivatives transactions. This distinction can be attributed to the differences in the financial environments between the US and the Netherlands. These, and other results, strongly suggest that institutional differences between the US and the Netherlands have an important impact on risk management practices and derivatives use across US and Dutch firms.