Corporate derivative use and the composition of CEO compensation

This paper analyzes whether the composition of a CEO's compensation package and SFAS 133, a regulation designed to increase transparency of derivative reporting, affect a firm's use of interest rate and currency derivatives to hedge risk. Using a panel of S&P500 firms during 1994-2000, we demonstrate the importance of properly aligning CEO incentives with derivative use. Results demonstrate that hedging is positively related to long-term CEO compensation, and negatively related to short-term CEO compensation as well as exercisable options compensation. We also show that changes in derivative reporting influence the relationship between CEO compensation and derivative use. Our paper thus highlight that CEO incentives and derivative reporting transparency are a significant factor in determining a firm's hedging use.