Objectives
The usefulness of a particular hedging strategy depends on both acceptability and quality. Acceptability refers to approval by those in the organization who will implement the strategy, and quality refers to the ability to provide better decisions. To be acceptable, a hedging strategy must be consistent with top management’s values and overall corporate objectives. In turn, these values and objectives are strongly motivated by management’s beliefs about financial markets and how its performance will be evaluated. The quality, or value to the shareholders, of a particular hedging strategy is, therefore, related to the congruence between those perceptions and the realities of the business environment.
The most frequently occurring objectives, explicit and implicit, in management behavior include the following:3
1. Minimize translation exposure. This common goal necessitates a complete focus on protecting foreign-currency-denominated assets and liabilities from changes in value resulting from exchange rate fluctuations. Given that translation and transaction exposures are not synonymous, reducing the former could cause an increase in the latter (and vice versa).
2. Minimize quarter-to-quarter (or year-to-year) earnings fluctuations owing to exchange rate changes. This goal requires a firm to consider both its translation exposure and its transaction exposure.
1Dow Chemical stated in its 2010 Form 10-K (p. 76) that ‘‘The primary objective of the Company’s foreign exchange risk management is to optimize the U.S. dollar value of net assets and cash flows, keeping the adverse impact of currency movements to a minimum.’’ Although a laudable objective, it is difficult to determine what specific actions a manager should take to accomplish it.
2Most of these elements are suggested in Thomas G. Evans and William R. Folks, Jr., ‘‘Defining Objectives for Exposure Management,’’ Business International Money Report (February 2, 1979): 37–39.
3 See, for example, David B. Zenoff, ‘‘Applying Management Principles to Foreign Exchange Exposure,’’ Euromoney (September 1978): 123–130.