DERIVATIVES HEDGING AND FIRM VALUE: A CASE OF NON-FINANCIAL FIRMS LISTED AT THE NAIROBI SECURITIES EXCHANGE IN KENYA

ABSTRACT Corporations have historically employed derivatives for a range of functions. While financial institutions often use them for trading or speculative activities, non-financial firms typically adopt them mainly for hedging purposes. This variation can be attributed in part to the reality that numerous non-financial companies listed on the Nairobi Securities Exchange exhibit Tobin’s Q ratios below 1, implying that their market valuations fall short of the cost required to replace their assets. This undervaluation can hinder their ability to raise capital or appeal to investors. The goal of this study was to analyze how using derivatives for risk management affects the value of companies listed on the stock market but not in the financial sector. The study mainly looked at how protecting against interest rate, commodity, and foreign exchange risks using derivatives affects the value of the organization. To support the criterion variable, the study employed agency theory, while the predictor variables were justified through the theories of purchasing power parity, interest rate parity, liquidity preference, and capital structure irrelevance. The research period spanned six years, from 2017 to 2022, a time when many firms failed to achieve the desired Tobin's Q ratio. A positivist research approach was adopted, employing a causal research design. The study concentrated on a population of 34 non-financial firms listed on the Nairobi Securities Exchange. Data were obtained through a combination of surveys and analysis of financial statements, emphasizing elements such as corporate governance, and the handling of risks associated with interest rate movements, fluctuations in commodity prices, and changes in foreign exchange rates. A range of diagnostic tests was performed to ensure data reliability, including checks for heteroscedasticity, autocorrelation, normality, stationarity, and model specification accuracy. Both descriptive and inferential statistical methods were used in the analysis, including measures such as mean, mode, standard deviation, percentiles, Pearson’s correlation, and panel regression techniques. The findings indicated that mitigating foreign exchange rate risk through hedging had a statistically significant impact on firm value (P = 0.000), as did hedging against interest rate risk (P = 0.001) and commodity price risk (P = 0.001). In light of these outcomes, the study recommends that policymakers promote the adoption of robust and customized hedging strategies by non-financial firms to effectively manage their exposure to financial risks. This could involve the use of currency options, forward contracts, or other derivative instruments.