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Managerial Entrenchment and Corporate Risk Management

We theoretically and empirically analyze the effects of managerial agency on corporate hedging and risk management. Our theoretical analysis indicates that even risk neutral entrenched managers of unlevered firms will optimally establish costly hedging positions. Moreover, our model presents novel prediction on the relationship between the extent of risk management and the level of managerial entrenchment and available cash flows. Using a unique and hand-collected dataset with detailed quarterly information on derivative positions by non-integrated exploration and production firms in the oil and gas industry during 1996-2008, we test these predictions and find strong support for them, even after controlling for factors used in the earlier literature. We thus provide a theoretical and empirical explanation for why corporations hedge even when it does not increase firm value.