The underinvestment problem and corporate derivatives use

We analyze the underinvestment problem as a determinant of corporate hedgin g policy. We find evidence of a positive relation between a firm's derivati ves use and its growth opportunities, as proxied by several alternative mea sures. For firms with enhanced investment opportunities, derivatives use is greater when they also have relatively low cash stocks. Firms whose invest ment expenditures are positively correlated with internal cash flows tend t o have smaller derivatives positions, which suggests potential natural hedg es. Our findings support the argument that firms' derivatives use may partl y be driven by the need to avoid potential underinvestment problems.