a survey on the use of derivatives in indonesia

295

Lantara—A Survey on the Use of Derivatives in Indonesia

Gadjah Mada International Journal of BusinessSeptember-December 2010, Vol. 12, No. 3, pp. 295–323

I Wayan Nuka LantaraGraduate School of Business Administration, Kobe University, Japan

This paper provides survey evidence on the use of derivativesamong firms listed on the Indonesian Stock Exchange. The findingshows that the participation rate in the use of derivatives is 28.8percent, much lower than those found in developed countries. Forthe derivatives non-users, insignificant risk exposure is reported asthe most important rationale for not using derivatives. Consumergoods industry constitutes the largest proportion of firms usingderivatives. The majority of respondents utilize derivatives to hedgeagainst financial risks rather than to speculate. Foreign currencyrisk and interest rate risk are the most important types of risks facedwith by respondents. Using the Chi-square and the Fisher’s exacttests, the result corroborates the size effect hypothesis, where the useof derivatives is more popular among large firms than small firms.

A SURVEY ON THE USE OF DERIVATIVES ININDONESIA

Keywords: derivatives; hedging; risk management

Category: Risk Management

* The author would like to thank Tadanori Yosano, Chitoshi Koga, F. Widyasari Dewi and HariPurnomo for their valuable comments and insightful suggestions.

296

Gadjah Mada International Journal of Business, September-December 2010, Vol. 12, No. 3

Introduction

Financial crisis that hit a numberof Asian countries in the mid-1997brought an invaluable lesson on theimportance of risk management to pro-tect firms from losing values and frombankruptcy risk. For the Indonesiancase, the severe impact of the crisiswas related to a vulnerable financialsystem and triggered by a sudden andhigh volatility of exchange rate(Sharma 2003). During that time, manyof Indonesian firms were faced with anenormous currency risk exposure dueto their huge short-term foreign debtswithout sufficient hedging position.

As one of the main countries inSoutheast Asia, Indonesia is charac-terized by its relatively high volatilityalong with promising growth.1 Accord-ingly, risk exposure and the types ofrisk sources faced with by the marketparticipants in Indonesia will increase,which then raise the need for the avail-ability of more types of derivativesinstruments to hedge against risks.Meanwhile, for some parties the de-rivatives securities could also be har-nessed as a means of speculation toyield higher return. Furthermore, theopening of the Jakarta Futures Ex-change (JFX) in December 2000 as thefirst Indonesian exchange that tradesfutures and the Indonesian Commodi-ties and Derivatives Exchange (ICDX)in March 2010 have also facilitated

many firms in Indonesia to be able tobuy and sell derivatives through theexchange floors.

Although firms all over the worldhave been using derivatives for de-cades, more evidence on the practicalaspect of the use of derivatives is stillneeded in order to better understandthe intensity of usage as well as thereasons why and how firms employderivatives. Numerous studies havebeen conducted around the world tohighlight the real world of the use ofderivatives, especially for the cases ofdeveloped countries. Some among oth-ers used a survey methodology, suchas Bodnar et al. (1996; 1998) in theU.S., Bodnar and Gebhardt (1998) inGermany, Ceuster et al. (2000) in Bel-gium, Mallin et al. (2001) in the U.K.,Berkman and Bradbury (1996) in NewZealand, Heaney et al. (1999) in Ja-pan, and Yu et al. (2001) in HongKong. However, evidence on the casesof developing countries is very lim-ited, such as Schiozer and Saito (2009)in Brazil. This study contributes to theliterature by showing evidence on thepractice of risk management with theuse of derivatives from other develop-ing countries in Asia, especially Indo-nesia.

The objective of this study is toprovide evidence from the real worldof derivatives usage by Indonesianfirms. Specifically, the study answers

1 As reported in the World Bank Report (2010) on “Indonesian Economic Quarterly: ContinuityAmidst Volatility,” Indonesian market is characterized by its promising growth and relatively highvolatility in terms of capital inflows/outflows, the fluctuation of exchange rates, and commodityprices.

297


some interesting questions, such as:(1) how large the participation rate isof the use of derivatives by Indonesianfirms; (2) the differences (if any) in theintensity of derivatives usage by Indo-nesian firms subject to different firmsize (large vs. small firms) as well asdifferent industries; (3) reasons thatmotivate Indonesian firms to use ornot to use derivatives; (4) the types ofrisks being managed; (5) the types ofderivatives used to mitigate risks; (6)the method used to measure risk expo-sure, and (7) the organization, infor-mation systems, and monitoring pro-cedures of the use of derivatives.

The questionnaires were sent to413 firms listed on the Indonesian StockExchange (IDX) in June 2010, con-taining principally similar questionsto Bodnar et al.’s (1996) survey study,with only a few modifications to ad-just with the Indonesian market. Intotal, 104 responses were obtained fromthe respondents. However, differentlyfrom other previous surveys, wherepaper questionnaires were distributedand collected via the regular post mail,this study utilizes the electronicwebpage survey. E-mails were sent tothe respondents, inviting them to par-ticipate in the survey by clicking theweb link on the survey webpage.

The findings show that the par-ticipation rate of derivatives use in the

whole sample is 28.8 percent, which ismuch lower than the findings in devel-oped countries.2 For the non-users ofderivatives, the main rationales for notusing derivatives are insignificant riskexposure and the costs of employingderivatives that exceed the expectedbenefits. There is also a tendency ofso-called “size effect” in derivativesusage, where larger firms are morelikely to use derivatives than smallfirms.3 In terms of industry categories,consumer goods industry has the high-est participation rate of the use ofderivatives compared to other indus-tries. Foreign currency risk and inter-est rate risk are reported to be the mostimportant types of risks faced with byrespondents. It is also found that for-eign currency forward and currencyswap are the most intensive types ofderivatives being used. In addition,Value-at-Risk (VaR) and scenarioanalysis are the most common meth-ods utilized to measure the risk expo-sure. Finally, most of the derivativesuser respondents indicate that they donot have a predetermined reportingschedule of the derivatives transac-tions to the board of directors.

This paper proceeds as follows.Section 2 reviews relevant theory andsome previous studies on derivativesusage. Section 3 discusses data sourcesand the characteristics of respondents.

2 See, for instance, the percentage of derivatives users of 50 percent in the U.S. (Bodnar et al.1998); 60 percent in U.K. (Mallin et al. 2001); 60 percent in Japan (Heaney et al. 1999); or 37 percentin Hong Kong (Yu et al. 2001).

3 The percentage of derivatives users for the group of large firms in this study is 48.9 percent,much higher compared to small firms group (9.6%). The results of Pearson Chi-square and Fisher’sexact tests also statistically support the hypothesis.

298


Section 4 presents the results, includ-ing descriptive analysis and statisticaltest results of the size effect hypoth-esis on the use of derivatives. Section5 concludes.

Literature Review

The negative impact of economiccrisis mainly caused by the volatilityof exchange rates and input prices couldaffect firm value significantly or evenlead companies to bankruptcy. Thecalamity did befall many companiesduring the crisis, including corpora-tions in Indonesia in the mid of 1997,when many Indonesian firms werethwarted by huge exchange rate riskexposure with insufficient hedgingposition.

Before the introduction of riskmanagement tools and techniques,stockholders were willing to acceptmarket sentiment fluctuation or inputprice changes as the explanations forpoor company performance. However,investors nowadays expect managersto effectively manage every type ofrisk in order to minimize losses. Smithand Stulz (1985) argue that the appli-cation of risk management benefits thefirm since it will increase firm valuethrough tax deductibility effect, themitigation of financial distress costs,and the improvement in performanceas a consequence of reduced financialrisk. Stulz (2004) suggests that deriva-tives can also be used as another alter-

native to mitigating the types of risksthat cannot be alleviated using tradi-tional methods (diversification or in-surance), such as foreign exchangerisk, interest rate risk, commodity pricerisk, or weather risk.

Despite the positive side of de-rivatives utilization as part of corpo-rate risk management, a vast array ofterrible stories on the misuse of deriva-tives have been prevalent and causedenormous losses to many companies.Some cases, such as Sumitomo Corpo-ration, Kashima Oil and Daiwa Bankin Japan, Barings Bank in Singapore,or Orange County in the U.S., are someamong many bad fairy tales (Karpinsky1998). However, it is not appropriateto generalize that derivatives securi-ties always render massive losses oreven lead firms to bankruptcy. If welook at the worst cases more carefully,the real problem was more likely to liein the incorrect way on using deriva-tives. Firms have to make sure thatthey trade derivatives aptly, meaningthat the risk of derivatives position hasto be measured and monitored pre-cisely (Stulz 2004).

Survey studies on the practicaluse of derivatives have been conductedin across countries; most of them weredone in developed countries.4 A re-markable prior survey study on the useof derivatives was documented byBodnar et al. (1998) in the U.S. Theirsurvey covered 2,000 random non-financial firms, using postal mail dis-

4 A summary of previous survey studies can be seen in Table 1. The summary can also be usedas a brief comparison of the findings across countries including the finding of this study.

299


tributed in November 1994, with aresponse rate of 20.7 percent. The mainfinding of their survey is that 50 per-cent of the overall responding firmsuse derivatives, mostly the large sizedfirms (83%), and only a small fraction(12%) among small firms. In terms ofindustry categories, they find that themost intensive user of derivatives isthe primary product industry.

Bodnar and Gebhart (1998) mailedquestionnaires to 368 non-financialfirms in Germany in Spring 1997, witha response rate of 34.2 percent. Theyconclude that derivatives usage in

Germany from the overall sample ismore widespread (78%) relative tothose found in the U.S. (50%) byBodnar et al. (1998). Different fromthe case in the U.S., they report that theservices industry constitutes the high-est participation rate of derivatives.

For the case of the U.K., Mallin etal. (2001) performed a survey studyusing postal mail questionnaires. Theirsample was comprised of 800 non-financial firms, and 230 responded tothe questionnaires. Overall, 60 per-cent of the respondents acknowledgetheir uses of at least one type of deriva-

Table 1. Summary of Some Survey Evidence on the Use of Derivatives

PANEL A. Authors and Methodologies

Authors Bodnar et al. (1998)

Mallin et al. (2001)

Bodnar and Gebhardt

(1998)

Alkeback and Hagelin (1999)

Ceuster et al. (2000)

Country (year) surveyed

USA (1997) U.K. (1997) Germany (1997)

Sweden (1996) Belgium (1997)

Industry coverages

Non-financial firms

Non-financial firms

Non-financial firms

Non-financial firms

Non-financial firms

Samples (respond rate)

2,000 (20.7%) 800 (28.8%) 368 (34.2%) 213 (76.6%) 334 (21.9%)

Data collection method

Questionnaire (postal mail)





Authors Heaney et al.

(1999) Yu et al. (2001)

Schiozer and Saito

(2009)

Lantara (2010)

Country (year) surveyed

Japan (1999) Hong Kong (1998)

Brazil (2004) Indonesia (2010)

Industry coverages

All industries All industries Non-financial firms

All industries

Samples (respond rate)

913 (33%) 140 (54.3%) 378 (19.6%) 413 (25.2%)

Data collection method

Questionnaire

(postal mail)

Questionnaire

(postal mail)

Questionnaire

(E-mail)

Questionnaire

(E-mail)

300


Continued from Table 1

PANEL B. Main Findings Derivatives

user (overall) 50% 60% 78% 52% 65.8%

Users by large (small) firms

83% (12%) 100% (29%) 75% (50%) 86% (18%) 86.9% (65.2%)

Industry with highest user

Primary product

Utilities Service Manufacture Chemical industry

Most important risk being exposed

FX risk; Interest rate risk





Most intensive derivatives being used

Foreign currency derivatives

FX forward; Interest rate swap


FX forward;

Interest rate swap


Most important reasons why not use derivatives

Small risk exposure; Cost exceed benefit

Not significant exposure; Cost of derivatives

Not significant exposure; Availability of other istruments

N.A Policy restriction; Availability of other istruments

Main purpose of using derivatives

Hedging Hedging Hedging Hedging Hedging

Most common method of risk measurement

VaR Scenario Analysis; VaR

Scenario Analysis;

VaR

N.A VaR;

Scenario Analysis

Derivatives user (overall)

60% 37% 57% 28.8%

Users by large (small) firms

N.A N.A 91.9%

(21.6%)

48.1%

(9.6%)

Industry with highest user

N.A N.A N.A Consumer Goods

Most important risk being exposed





Most intensive derivatives being used




FX forward; Currency swap

Most important reasons why not use derivatives

N.A Cost exceed benefit;

Not familiar with derivatives

N.A Insignificant risk exposure; Cost exceed benefit

Main purpose of using derivatives

Hedging Hedging Hedging Hedging

Most common method of risk measurement

Mark-to-market amount

VaR;

Building Block

N.A VaR;

Scenario Analysis

301


tives. Their finding also supports thesize effect hypothesis, where 100 per-cent of larger firms are derivativesusers, absolutely much higher than theparticipation rate among small firms(29%).

Alkeback and Hagelin (1999) car-ried out a survey study on 213 non-financial firms in Sweden. With a highresponse rate (76.6%), they find evi-dence that 52 percent of the sample arederivatives users, with manufacturingindustry being the most intensive in-dustry that uses derivatives. The sizeeffect is also confirmed, shown by thefact that 86 percent of large firms arederivatives users, much higher com-pared to the rate of the group of smallfirms (18 percent). However, theirstudy did not reveal the reasons whyalmost half of the sample firms did notuse derivatives. Moreover, their studyalso did not disclose the most commonmethods used to measure risk expo-sure.

Evidence from Asian countries isprovided by Heaney et al. (1999) forthe case of Japanese firms and Yu et al.(2001) for the case of Hong Kong.Their findings show that the percent-age of derivatives usage by Japanesefirms is much higher (60%) vis-à-visthat by Hong Kong firms (37%). Bothstudies covered sample not only fromnon-financial industries, but also fromfinancial industry. They find that cur-rency and interest rate risks are consid-ered the most important types of risks.With respect to main hedging instru-ments, their study reports that cur-rency forward and interest rate swap

contracts are the most popular instru-ments.

For the case of developing coun-tries, Schiozer and Saito (2009) con-ducted a survey study in Brazil. Theyused electronic mail questionnairesdistributed to 378 non-financial firmslisted on the Brazilian Stock Exchange.Surprisingly, the finding shows a highpercentage of derivatives usage (54%),with 92 percent of them belong to thesample of large firms, and only 21.6percent to the sample of small firms.Consistent with findings in other coun-tries, they provide evidence that cur-rency risk and interest rate risk areconsidered the most pivotal types ofrisks, and currency forward and inter-est rate swap contracts are the mostpopular instruments to mitigate therisks. However, they did not investi-gate the reasons behind the decisionsof respondents not using derivatives.

Some previous studies also high-lighted the existence of size effect onthe use of derivatives. It is hypoth-esized that the larger the firm size, thehigher the tendency to use derivatives.Many empirical studies have foundevidence on the positive associationbetween firm size and the use of de-rivatives, such as Borokovich et al.(2004) in the U.S., Berkman andBradbury (1996) in New Zealand,Nguyen and Faff (2002), and Brailsfordet al. (2003) in Australia, Yosano andLantara (2010) in Japan, and Lantara(2010) in Indonesia. Some other sur-vey studies also support the size effecthypothesis, such as the study by Bodnaret al. (1998) in the U.S., Mallin et al.

302


(2001) in the U.K., Alkeback andHagelin (1999) in Sweden, or Schiozerand Saito (2009) in Brazil.

The basic argument behind thesize effect hypothesis is the existenceof economies of scale, where largerfirms are assumed to have better re-sources to deal with the application ofderivatives programs (Smith and Stulz1985). Larger firms are also more fea-sible to bear the costs of derivativesprograms, which involve initial setupcost, operating cost, and monitoringcost of hedging strategies (Brailsfordet al. 2005). Therefore, this study con-jectures that the larger the firm, themore likely that it uses derivatives.

Methodology

Data in this study were obtainedfrom all 413 firms listed on the Indone-sian Stock Exchange (IDX) in June2010, covering all nine industries ac-cording to the IDX industry classifica-tion. The respondents consisted of fi-nance directors, risk managers, and/orcorporate secretaries5of the samplefirms who were assumed to have morethan sufficient knowledge of the prac-tical aspect of derivatives usage intheir firms.

The questionnaire6 is comprisedof 23 questions, containing principallysimilar questions to Bodnar et al.’s

(1998) survey study, such as: the in-dustry to which the firm belongs,whether or not the firm uses deriva-tives, the reasons why it decides not touse derivatives, the types of risks facedwith, the types of derivatives instru-ments used, risk assessment methods,and controlling and reporting proce-dures. At first, the pilot test was con-ducted by sending questionnaires to30 randomly chosen companies listedon the Indonesian Stock Exchange,and six companies responded. Basedon the responses obtained from thepilot test, few questions in the ques-tionnaire set were modified in order toadjust with the Indonesian market re-spondents.

In order to increase the responserate, the distribution of the question-naires was carried out in two consecu-tive periods. The first phase of distri-bution was conducted in June 2010,followed by the second distributionthree months after the first wave bysending a reminder message to thenon-responding respondents. The to-tal fully responded questionnaires are104 (71 responses obtained from thefirst distribution and 33 from the sec-ond phase), indicating a response rateof 25.2 percent. The profiles of re-spondents based on their hierarchicalpositions in their respective firms are:26 finance directors (25%), 16 risk

5 Under the Indonesian Company Law (1995), a publicly listed company is required to appointa corporate secretary. Corporate secretary serves as an investor relations officer as well as acompliance officer and keeper of corporate documents. One of the members of the Board ofDirectors might be designated as a corporate secretary.

6 The detailed questionnaire can be obtained from the author.

303


managers (15%), and 62 corporate sec-retaries (60%).

Different from previous surveyswhere paper questionnaires were dis-tributed and collected via regular postmail, this survey study utilizes the elec-tronic webpage survey. All respon-dents were contacted by e-mail mes-sages, inviting them to participate inthe survey by clicking the web link onthe survey webpage. The main advan-

tage of this method is that all the re-sponses from respondents can be col-lected efficiently and instantly as therespondents fill out the questionnaires.It is also easier for the researcher andrespondents to communicate wheneverneeded, such as when a certain respon-dent requests for further clarificationon particular questions in the ques-tionnaire set.

Table 2. Description of Firm Size (in billions of Indonesian Rupiahs)

This table shows the mean, minimum, maximum, and standard deviation values of thewhole sample (104 firms), as well as the groups of large firms (52 firms) and small firms(52 firms). The values are in billions IDR. MVEBVL stands for Market Value of Equityplus Book Value of Liabilities.

PANEL A: All Sample (104 firms)

Mean Minimum Maximum Std. Dev.

Total Asset 16,805.6 17 394,617 50,556.5

MVEBVL 22,536.7 25.3 456,890 65,580.8

Total Sales 6,014.3 1 98,526 13,504.9

PANEL B: Large Firms (52 firms)

Total Asset 33,045.9 1,623 394,617 67,999.6

MVEBVL 44,442.9 1860.8 456,890 87,790.2

Total Sales 11,722.9 1271 98,526 17,372.7

Small Firms (52 firms)

Total Asset 565.3 17 1,609 509.5

MVEBVL 630.6 25.3 1,808.2 565.3

Total Sales 305.7 1 988 285.8

304


This study also investigates theexistence of size effect on the use ofderivatives for the case of Indonesia.At first, the sample firms were rankedand divided into two equal numbers ofgroups (large vs. small firms) based onthree proxies for firm size: (1) totalassets; (2) total market value of equityplus total book value of liabilities; and(3) total sales. The value of 1 is givento the sample firm that reports the useof derivatives, and 0 otherwise. Thestudy utilizes the chi-square test andthe Fisher’s exact test to examine thedifferences in derivatives usage be-tween the two groups.

The description of the firm size inthis study are presented in Table 2. Asshown in the table, the average valueof total assets of large firms is 59 timeslarger than that of small firms group.In terms of market value of equity plusbook value of liabilities, large firmshave the value of 71 times bigger thanthat of small firms. The same pattern is

also found in terms of total sales, wherelarge firms show 38 times larger salesthan that of small firms group.

Results

Users vs. Non-users ofDerivatives

The participation rate of deriva-tives securities in this study is calcu-lated from the 104 sample firms re-sponding to the questionnaires. Asshown in Figure 1, the finding revealsthat 28.8 percent (30 firms) are deriva-tives users, while the rest of the sample(71.1%) report that they have not em-ployed any derivatives securities. Theresult is much lower compared to thosefound in Western countries, such as 50percent in the U.S. (Bodnar et al. 1998),60 percent in the U.K. (Mallin et al.2001), or 65.8 percent in Belgium(Ceuster et al. 2000). The result is alsoinferior when compared to the find-

Figure 1. Participation Rate of the Use of Derivatives

The participation rate is calculated by dividing the total number of respondents reportedto use derivatives to total respondents. Of the total 104 respondents, 30 respondents areclassified as derivatives users and 74 firms are non-users.

305


ings in the developed countries in Asia,such as 60 percent in Japan (Heaney etal. 1999) and 37 percent in Hong Kong(Yu et al. 2001), or even when com-pared to the finding in Latin America,such as 57 percent in Brazil (Schiozerand Saito 2009). The relatively lowparticipation rate of the use of deriva-tives in this study indicates that thedevelopment of derivatives market inIndonesia is still in the stage of in-fancy.7 This fact supports the mappingresult by Hohensee and Lee (2003) onthe level of derivatives market devel-opment among several countries in theAsian region. They conclude that HongKong and Singapore have the mostadvanced derivatives markets, whereasother countries such as Philippines,

China and Indonesia are still in thevery early stage of development.

This study also investigates theuse of derivatives across various in-dustry categories and between largefirms and small firms. As shown inFigure 2, consumer goods industryconstitutes the highest percentage ofderivatives users (75%), followed byinfrastructure, utilities and transporta-tion industry (58.3%), and agriculturalindustry (50%). This finding is incon-sistent with the finding in the U.S.(Bodnar et al. 1998), who find theprimary product at the top of the rank,or in the U.K. by Mallin et al. (2001),who document that the utilities indus-try is the most intensive industry thattrades derivatives. The fact that the

7 The establishment of the Indonesian derivatives market is in the very early stage compared tothose running in developed countries. According to the IDX Fact Book (2010), stock options andindex futures were introduced in 2004, with the total transaction of less than 2 percent compared tothe total transaction in the equity market. For the commodity derivatives market, the Jakarta FuturesExchange (JFX) was introduced in December 2000, and the Indonesian Commodities andDerivatives Exchange (ICDX) was established recently in March 2010.

Figure 2. The Use of Derivatives Across Industry Categories

Industry categorization in this study is based on the Indonesian industry classification taken fromthe IDX Fact Book 2010, which splits all the firms listed on the IDX into nine different industrycategories. N on the parentheses stands for the total number of firms belonging to a particularindustry.

306


consumer goods industry8 contains thegreatest percentage of derivatives us-ers might be related to the nature of theindustry per se, where it is incessantlychallenged by relatively high currencyrisk exposure as the consequence of itsoperations of importing inputs fromforeign countries or exporting prod-ucts to foreign nations.

By firm size, the finding showsthat derivatives usage is more com-mon for large firms than for smallfirms. Using three proxies for the firmsize, the results indicate that the use ofderivatives is more popular in the group

of large firms relative to the sample ofsmall firms. As exhibited in Figure 3,using total assets as the proxy for firmsize, the evidence indicates that 48.9percent of large firms are derivativesusers, much higher than that for smallfirms (9.6%). The same pattern is alsofound when the second and the thirdproxies for firm size are employed,where large firms are much superior interms of the participation rate of de-rivatives usage (50%) compared tothat for small firms (7.7%). The find-ing signifies the size effect hypothesis,where larger firms are more likely to

Figure 3. Percentage of Derivatives Usage for the Samples of Large andSmall Firms

8 Based on the Indonesian Industry Classification in IDX, consumer goods industry consists offirms operating in certain businesses such as food and beverages; tobacco manufacturers; pharma-ceuticals; cosmetics and households; and house wares.

This figure illustrates the percentage of derivatives usage among large firms and small firms. Firstly,the whole sample (104 firms) were ranked based on the values of three proxies for the firm size: (1)total assets (TA); (2) market value of equity plus book value of liabilities (MVEBVL); and (3) totalsales (TS). Next, the sample was divided into two separate groups (large vs. small firms) accordingto each proxy. Each group consists of 52 firms. The percentage of derivatives users is calculatedby dividing the number of companies reported to use derivatives to the total number of firms in eachgroup.

307


use derivatives than small firms. Thisalso corresponds with the results ofprevious studies, such as Bodnar et al.(1998) in the U.S., Mallin et al. (2000)in the U.K., Alkeback and Hagelin(1999) in Sweden, or Schiozer andSaito (2009) in Brazil.

To examine the existence of thesize effect, this paper employs the chi-square and the Fisher’s exact tests. Asshown in Table 3, the results substan-tiate the size effect hypothesis using

all three proxies for firm size, with asignificance level of 1 percent. In otherwords, based on the results of thePearson Chi-square and the Fisher’sexact tests, there is a strong indicationthat the use of derivative by large firmsis significantly higher than that bysmall firms. Again, this evidence is inline with the findings provided byCeuster et al. (2000) for the case ofBelgium and Schiozer and Saito (2009)in Brazil.

Table 3.Statistical Test Results of the Size Effect Hypothesis on DerivativesUsage

* Statistically significant at 1 percent confidence level.

This table shows the results of crosstab between size of the sample firms (large vs. small firms) andthe derivatives usage (users vs. non-users of derivatives). N stands for the number of sample firms.There are 104 sample firms in total, where 52 firms belong to large firms group and 52 firms to thesmall firms group. To test the mean difference in the number of users vs. non-users in both sizegroups, this study utilizes the Pearson Chi-square and Fisher Exact tests.

Size = Total Assets

N = 104 User Non-user

Total Pearson

Chi2 Fisher’s

Exact

Large firms 25 27 52

Small firms 5 47 52

Total 30 74 104 18.74* 0.00*

Size = MVEBVL

Large firms 26 26 52

Small firms 4 48 52

Total 30 74 104 22.68* 0.00*

Size = Sales

Large firms 26 26 52 Small firms 4 48 52

Total 30 74 104 22.68* 0.00*

308


The Purposes of UsingDerivatives and the UsageIntensity

The purposes of using derivativesare an interesting fact to be investi-gated in this study. For the derivativesuser respondents, they were asked tostipulate what their purposes of usingderivatives were, whether for hedg-ing, speculation, or merely taking aposition. 30 answers were gatheredfrom the derivatives user respondents.As illustrated in Figure 4, most of thederivatives user respondents (97%)state that they utilize derivatives forhedging purposes, and only one firmclaims to have a position-taking pur-pose. As anticipated, this finding isconsistent with the results from previ-

ous survey studies, such as Bodnar etal. (1998), Heaney et.al (1999), Mallinet al. (2001), or Schiozer and Saito(2009). Moreover, for the case of In-donesian firms,9 it is sometimes men-tioned explicitly in the firm’s policythat the use of derivatives instrumentsfor speculation purposes is prohibited.

Another interesting aspect inter-twined with the motivation to use de-rivatives is the perception of respon-dents on the importance of derivativesas a risk management instrument. Intotal, 30 responses were gotten for thisquestion. As shown in Figure 5, morethan 95 percent of the answers tend toperceive derivatives as an importantinstrument to manage risks. The resultcorroborates the finding in Hong Kongby Yu et al. (2001), where they find

9 Upon observing the annual reports of several derivatives users from the sample in this study,it is commonly found that most of the sample firms declare that the use of derivatives is only forhedging purposes, and speculation is certainly prohibited.

Figure 4. The Purposes of Using Derivatives

This figure illustrates the replies from derivatives user respondents on what the purposes of usingderivatives are. In total, 30 answers were obtained from the respondents.

309


Figure 5. The Perception of Derivatives User Respondents on the Impor-tance of Derivatives

The result is calculated from 30 replies of derivatives user respondents. The respondents were askedto indicate their perception on how important the use of derivatives is as part of a risk managementstrategy.

This figure illustrates the answers of 30 derivatives user respondents when they were asked todesignate the intensity of derivatives usage in the recent year compared to the preceding period.

Figure 6. Trend of the Magnitude of Derivatives Usage in the Current YearCompared to the Previous Year

310


that more than 60 percent indicate theuse of derivatives as an important as-pect in risk management.

Figure 6 depicts the response tothe question of how the intensity ofderivatives usage is in the present yearcompared to that in the preceding year.This question was asked to the firmsusing derivatives. From the total 30responses, 63 percent report that theintensity of derivatives usage is con-stant, 33 percent declare a decreasingtrend, and only 3 percent of the an-swers reveal that the intensity is in-creasing. The result indicates that thetrend of the magnitude of derivativesusage tends to be constant or evendecrease over the period of this study.This could also imply that most of therespondents to this question are reluc-

tant to increase the magnitude of de-rivatives transactions. Some most re-cent horrible stories on the excessiveuse of derivatives which caused severefinancial problems, such as the bank-ruptcy of Lehman Brothers, could alsospread the fear on the companies inIndonesia such that they became morecautious in using derivatives. The find-ing is consistent with the conclusion ofLantara (2010), who conducted anempirical study on the determinants ofderivatives usage by non-financialfirms listed on the IDX over the periodof 2005-2009. One of the main find-ings shows that there is a slightly de-creasing pattern in the magnitude ofderivatives usage by Indonesian firmsespecially after 2008.

Figure 7. The Reasons Why Respondents Decided Not to Use Derivatives

This figure illustrates the most important reasons behind the decisions of respondents on not to usederivatives. Non-user derivatives respondents were asked to choose three most important explana-tions why their firms did not use derivatives. N on the parentheses stands for the number of responsesfrom the derivatives non-user respondents.

311


Reasons Why Not to UseDerivatives

Respondents who acknowledgedtheir not using derivatives were askedto choose three most important out ofseven possible reasons why they de-cided not to use derivatives. As re-vealed in Figure 7, the most salientreason according to the answers ofrespondents is that the risk exposure isinsignificant. The second and the thirdmost important reasons are the costs toimplement derivatives programs ex-ceeding the benefits and the difficultyin valuing and pricing derivatives, re-spectively. The findings of this studyare consistent with the conclusion of

previous studies, such as Bodnar andGebhardt (1998) in Germany andMallin et al. (2001) in the U.K.

Two questions in the question-naires also asked the respondents toindicate the proportion of their firms’operating revenues and operating costsdenominated in foreign currencies overtotal assets. As illustrated in Figure 8,more than 70 percent of the answersfrom respondents affirm that the frac-tion of their firms’ operating revenuesdenominated in foreign currenciescompared to total assets range from 0percent to 5 percent, and only less than10 percent of respondents declare thatthe fraction is more than 25 percent of

Figure 8. Percentage of Operating Revenues and Operating Costs Denomi-nated in Foreign Currencies Scaled by Total Assets

The results are obtained from the answers of respondents on how much their firms’ operatingrevenues and operating costs are denominated in foreign currencies compared to total assets. In thisquestion, respondents were asked to choose only one option from the possible answers. Totalanswers from respondents were 104.

312


total assets. The same pattern is alsoobserved in terms of how much therespondents’ operating costs desig-nated in foreign currencies are relativeto total assets, where 78 percent ofrespondents choose the range between0 and 5 percent. The relatively lowratios of operating revenues and oper-ating costs in foreign currencies tototal asset might be related to the find-ing that respondents perceive insig-nificant risk exposure as the foremostreason why they do not use deriva-tives.

Types of Risks Being Exposed toand Types of Derivatives used

When asked about the types ofrisks being managed, the majority ofrespondents perceive foreign currencyrisk (54%) followed by interest rate

risk (32%) and commodity risk (10%),as illustrated in Figure 9. This findingis consistent with the conclusion ofprevious studies, such as Bodnar et al.(1998) in the U.S., Bodnar andGebhardt (1998) in Germany, Mallinet al. (2001) in the U.K., Ceuster et al.(2000) in Belgium, or Heaney et al.(1999) in Japan.

Many types of derivatives instru-ments are available to mitigate certaintypes of risks being faced by the firms.One of the questions on the question-naires also inquired respondents toindicate what types of derivatives be-ing used to mitigate risks. As depictedin Figure 10, the furthermostanswers belonged to forward contract(35%), followed by currency swap(34%) and interest rate swap (27%).There is a link when we connect thepattern of the finding on this question

Figure 9. What Types of Risks Are the Respondents Being Exposed to?

The result is obtained from the answers of the entire 30 derivatives user respondents on the typesof risks being faced with. In this question, respondents were allowed to choose more than one answerwhenever needed, and in total 56 answers were collected.

313


(in Figure 10) and the result on thequestion of what types of risks beingmanaged (in Figure 9). In order tomitigate foreign currency risks andinterest rate risks, the respondentsclaimed that the most common typesof derivatives being used are: forwardcontract, followed by currency swapand interest rate swap. In general, theresult of this study is s consistent withthe finding of Bodnar et al. (1998),Ceuster et al. (2000), or Yu et al.(2001).

This study also further examinesthe complexity of derivatives instru-ments used by the respondents. De-rivatives users were required to indi-cate as to what types of derivativesthey had used. As shown in Figure 11,

the majority of respondents (80%) in-dicate that they have employed basicand simple types of derivatives, fol-lowed by taking long/short positions(10%), using both basic and compli-cated derivatives (7%), and only 3percent claim to use sophisticated de-rivatives. The result is strongly com-parable with the findings of previousstudies on the use of derivatives, suchas Bodnar et al. (1998), Ceuester et al.(2000), Mallin et al. (2001) or Yu et al.(2001). The pattern that a large num-ber of respondents only utilize simpleand basic types of derivatives instru-ments confirms the finding in Figure10, where forward and currency swapcontracts are the most common typesof derivatives used.

Figure 10. What Types of Derivatives Are Being Used?

The result is obtained from the answer of respondents on what types of derivatives are being used.This question is aimed to the derivatives user respondents. In this question, respondents are allowedto choose more than one answers whenever needed, and in total 86 answers were obtained.

314


Methods Used to Measure RiskExposure

The ability of a firm to appraisethe magnitude of risk exposure beingfaced with is also a crucial part of riskmanagement strategy. There are manykinds of methods available to helpfirms assess the enormity of risk expo-sure, such as Value-at-Risk (VaR),scenario analysis, building block ap-proach, options sensitivity, or price-value of basis point method. In order toobtain the real-world representation ofthe methods used to measure risk ex-posure, the respondents of derivativesusers were asked to specify one ormore risk exposure measurement meth-ods practiced in their firms. As shownin Figure 12, of the 58 answers ob-tained, the most popular method isVaR (48%), followed by scenarioanalysis (34%), and price value of

basis point. This finding is in line withthose of Bodnar et al. (1998), Ceusteret al. (2000) and Yu et al. (2001), whoalso find that VaR is the most popularmethod used by their respondents.However, the result of this study doesnot support the finding of Heaney et al.(1999), who discover marked-to-mar-ket amount as the most popular methodinstead of VaR.

Figure 13 illustrates the repliesfrom derivatives user respondentswhen asked about whether they uti-lized certain software to help measurethe risk exposure. Of total 30 answersobtained, the result shows that nearly83 percent of respondents report thatthey use certain software packages tohelp measure the riskiness of theirfirms’ portfolios. The result of thisstudy is contradictory with the findingof Alkeback and Hagelin (1999), who

Figure 11. How Complicated Are the Types of Derivatives Being Used?

The result is drawn from the answers of respondents on how complex the types of derivatives beingused are. In this question, derivatives user respondents were required to choose only one possibleanswer, and 30 answers were obtained.

315


Figure 13. The Proportion of Respondents Who Utilize Certain SoftwarePackages to Measure the Enormity of Risk Exposure

The result is calculated from 30 responses of derivatives user respondents on the question of whetherthe respondents utilize specific software packages in measuring the magnitude of risk exposure.

The result is obtained from the replies of derivatives user respondents on the measurement methodsused to assess the magnitude of risk exposure. In this question, respondents might choose more thanone answer whenever necessary. In total, 58 answers were obtained.

Figure 12. The Methods Used to Measure the Magnitude of Risk Exposure

316


find that only less than 30 percent ofrespondents harness specific softwarepackages in measuring the risk expo-sure. A possible justification behindthis gap is due to the divergence of thetimeframe of the surveys; it is rela-tively easier and cheaper nowadays toobtain software packages either fromthe market or self-developed comparedto the circumstances in the precedingperiods.

Furthermore, for respondents ofderivatives users who stated that theyutilize a specific software package werenext asked what kind of software pack-ages being used. In this study, it is alsointeresting to investigate furtherwhether they just take it for granted ofthe standards software available in the

market, or whether they utilize self-developed software, or the combina-tion of it. As it can be seen from Figure14, most of the respondents answeredthey adopt standard software and thenmodify it to adjust with their internalneed (44%), while the rest stated thatthey develop their own software (36%),and 20 percent of the respondents de-picted that they utilize the softwareavailable in the market as it is. Thefinding indicates that majority of re-spondents are not taking the softwareas it is taken from the market, but theyneed to do some modification beforeusing the software. This finding issomewhat comparable with the find-ing of Yu et al. (2001) for the case ofHong Kong.

Figure 14.The Proportion Respondents Who Utilize Certain Software Pack-ages to Measure the Magnitude of Risk Exposure

The result is calculated from 30 responses of derivatives user respondents on the question whetherthe respondents utilize specific software packages in measuring the magnitude of risk exposure.

317


The derivatives user respondentswere next asked to indicate how fre-quent their firms reviewed the meth-ods, methodologies, or software pack-ages used to measure the risk expo-sure. As shown in the Figure 15, themajority of respondents mention a non-regular review (47%), 30 percent stateat least twice a year, and 20 percentindicate an annual review activity. Onlya small fraction of respondents (4%)say that they never review the methodsand software packages. In general, theresult indicates that the majority ofrespondents perceive the reviewingprocess of measurement methods andsoftware packages as necessary.

The Organization, InformationSystems, and MonitoringProcedures

The organization, informationsystems, and monitoring proceduresare very essential components in theemployment of derivatives. As can belearned from some disastrous cases ofthe use of derivatives, such as BaringsBank in Singapore, the fruitlessness ofinternal control could lead a firm tobear severe losses and finally destroythe value of the firm. This study alsoinvestigates the internal control proce-dures inside the sample of derivativesusers. The first question in this section

The figure shows the responses from 30 responses of derivatives user respondents on the questionof how frequent their firms revise the software packages used to assess the magnitude of riskexposure.

Figure 15.How Frequent the Firms Review the Methods and SoftwarePackages Used to Measure the Magnitude of Risk Exposure

318


is whether the firms have a writtenformal policy regarding the use of de-rivatives. The result in Figure 16 showsthat 70 percent of respondents claim tohave a formal written rule regardingthe use of derivatives, and only a fewfirms (30%) state that they do not havea documented policy. The result indi-cates that the respondents are aware of

the importance of a formal writtenpolicy as guidance in using deriva-tives. The finding is comparable withthe evidence provided by Bodnar et al.(1998) and Mallin et al. (2001), whofind that the proportion of the samplethat have a documented policy is morethan 70 percent.

Figure 16. Does the Firm Have a Formal Written Policy Regarding the Useof Derivatives?

The figure shows the replies from 30 responses of derivatives user respondents on the question ofwhether their firms have a documented policy on derivatives usage.

Figure 17. Does the Risk Management Department Have a Certain Level ofIndependent Authority Over Derivatives Usage?

The figure reveals the answers from 30 responses of derivatives user respondents on the questionof whether they have a certain level of independency in the decision-making process of derivativesusage.

319


The next question is pertaining tothe independency of the risk manage-ment department with respect to de-rivatives usage. As shown in Figure17, of the 30 responses, most of therespondents indicate that, to some ex-tent, the risk management departmenthas the authority to make decisions onderivatives usage. The result is some-what comparable to the finding of Yuet al. (2001) for the case of HongKong.

Subsequently, this study exam-ines whether the derivatives user firmsembrace the risk limit as part of thewhole strategy in derivatives usage.The presence of risk limit, to someextent, could be used to control themagnitude of derivatives usage. Asshown in Figure 18, a large fraction ofrespondents (73%) state that their firms

have a certain risk limit. Again, theresult is comparable to the finding ofYu et al. (2001).

Figure 19 shows the responsesfrom the total of 30 derivatives userrespondents when they were askedabout the frequency of monitoring ac-tivities over the risk limit. The resultdepicts that most of the respondents(67%) do not have a regular period ofmonitoring the risk limit. There aresome other firms (30%) that state thatthey monthly monitor the risk limit,and only one firm (3%) reports thatthey check the risk limit daily. Thepattern found in this query supportsthe finding of Bodnar et al. (1998), butsomewhat contrasts with the findingof Yu et al. (2001) where they find that85 percent of the respondents monitorthe risk limit daily.

Figure 18. The Presence of Risk Limit

The figure shows the proportion of the answers from 30 responses of derivatives user on the questionof whether they have a certain risk limit.

320


The last section of the questionasked to the derivatives users is aboutthe frequency of reporting derivativestransactions to the board of directors.As revealed in Figure 20, more than 50percent of respondents indicate thatthey do not have a customary time toreport the derivatives transactions tothe board of directors. More than 20percent of respondents designate thatthey report to the board monthly, andonly a small fraction of respondents

state a different period of reportingtime. The result offers a support to thefinding of Bodnar et al. (1998) wherethey find that five percent of the re-spondents do not schedule the report-ing period to the board of directors.However, the pattern in this study is onthe contrary to the finding of Ceusteret al. (2000), who document that themajority of respondents report the de-rivatives transactions to the board ofdirectors every month.

Figure 19. How Frequent the Monitoring Activities Over the Risk Limit Is?

The figure illustrates the pattern of monitoring activities over the risk limit. The proportion iscalculated from the answers from 30 responses of derivatives users.

321


Conclusion

This paper reports the results of asurvey study on the real-world prac-tices of derivatives usage by Indone-sian firms. The main objective of thestudy is to reveal the description ofseveral aspects of the use of deriva-tives, such as the participation rate ofderivatives usage in Indonesia, themajor reasons why firms decide not touse derivatives, the types of risks facedwith and what kinds of derivativesharnessed to mitigate the risks, themethods used to appraise the magni-tude of risk exposure, and the monitor-ing systems over the use of derivativespracticed by the firms. This study alsoexamines the existence of size effecton the use of derivatives.

The main finding reveals that 28.8percent of respondents are derivativesusers. The result is much lower thanthose in developed countries, indicat-ing that the development of deriva-tives market in Indonesia is still at avery early stage. The main reasonsstated by the non-users of derivativesare insignificant risk exposure and thecosts of employing derivatives pro-grams exceeding the benefits. The re-sult also substantiates the size effecthypothesis, where large firms are morelikely to use derivatives than smallfirms. In terms of the types of risksbeing exposed to, the result shows thatforeign currency risk and interest raterisk are the most important types ofrisks faced with by respondents, andconsistently foreign currency forward

Figure 20. How Frequent the Reporting of Derivatives Activities to theBoard of Directors Is?

The figure demonstrates the answers of 30 derivatives user respondents when asked about thefrequency of the reporting activities of derivatives transactions.

322


and currency swap contracts are themost intensive types of derivativesused. Value-at-Risk (VaR) and sce-nario analysis are reported as the mostcommon methods utilized to measure

the risk exposure. Eventually, this studyalso reveals that the respondents donot have a predetermined fixed sched-ule of reporting and monitoring cer-tain activities of derivatives usage.

References

Alkeback, P., and N. Hagelin. 1999. Derivative usage by nonfinancial firms in Sweden withan international comparison. Journal of International Financial Management andAccounting 10: 105-120.

Berkman, H. and M. E., Bradbury. 1996. Empirical evidence on the use of derivatives.Financial Management 2: 5-13.

Bodnar, G. M., G. S. Hayt, and R. C. Marston. 1998. 1998 Wharton survey of financial riskmanagement by U.S. non-financial firms. Financial Management 27: 70-91.

Bodnar, G. M. and G. Gebhardt. 1999. Derivatives usage in risk management by U.S. andGerman non-financial firms: A comparative survey. Journal of International Finan-cial Management and Accounting 10: 153-187.

Borokovich, K. A., K. R. Brunarski, C. E. Crutchley, and B. J. Simkins. 2004. Boardcomposition and corporate use of interest rate derivatives. Journal of FinancialResearch 2: 199–216

Brailsford, T. J., R. Heaney, and B. R. Oliver. 2003. Practices and attitudes to derivativesuse in Australian commonwealth organizations. Australian Journal of Public Admin-istration 62: 87–100.

Brailsford, T., R. Heaney, and B. Oliver. 2005. Use of derivatives in public sectororganizations. Accounting and Finance: 45: 43-66.

Hohensee, M. and K. Lee. 2003. A survey on hedging markets in Asia: A description ofAsian derivatives markets from a practical perspective. BIS Paper 30: 261-281.

Indonesia Stock Exchange. 2010. IDX fact book 2010. Downloaded from http://www.idx.co.id/Portals/0/StaticData/Publication/FactBook/FileDownload/Fact%20Book%202010.pdf

Karpinsky, A. 1998. The risky business of risk management derivatives disasters: Revis-ited. Australian Banker 112: 60-66.

Lantara, I. W. N. 2010. The use of derivatives as a risk management instrument: evidencefrom Indonesian non-financial firms. Working Paper. Kobe University, Japan.

Mallin, C., K. Ow-Yong, and M. Reynolds. 2001. Derivatives usage in U.K non-financiallisted companies. European Journal of Finance 7: 63-91.

Nguyen, H. and R. Faff. 2002. On the determinants of derivative usage by Australiancompanies. Australian Journal of Management 27: 1-24.

323


Schiozer R. F. and R. Saito. 2009. The determinants of currency risk management in LatinAmerican non-financial firms. Emerging Markets Finance and Trade 45: 49–71.

Sharman, S. D. 2003. The Asian Financial Crisis: Crisis, Reform and Recovery, Manches-ter: Manchester University Press.

Smith, C. W. and R. M. Stulz. 1985. The determinants of firms’ hedging policies. Journalof Financial and Quantitative Analysis 20: 391–405.

Stulz, R. M. 2004. Should We Fear Derivatives? Journal of Economic Perspectives 18:173-192.

World Bank. 2010. World Bank Report on Indonesia Economic Quarterly: ContinuityAmidst Volatility. Downloaded from http://siteresources.worldbank.org/INT INDONESIA/ Resources/ publ i ca t ion / 280016-1264668827141 /67424851277258579 652/EQ_June2010/english.pdf

Yosano T., and I. W. N. Lantara. 2010. Bank-Firm Relationship and the Use of Derivativesin Japan. Working Paper. Kobe University, Japan.

Yu, E. S. H; I. C. H. Chin, H. F. Y. Hang, and G. L. C. Wai. 2001. Managing Risk by UsingDerivatives: The Case of Hong Kong Firms. Review of Pacific Basin FinancialMarkets and Policies 4: 417 – 425.

a survey on the use of derivatives in indonesia

Documents