Corporate management of exchange rate misalignment : the experience of U.K. firms 1979-82, 1987-92
Neoclassical approaches to the analysis of the impact of a floating exchange regime on business have tended to take the form of models or econometric relationships between exchange rate volatility and trade volumes. These have tended to conclude that floating does not harm trade. The rationale of this study is to examine the impact of prolonged currency overvaluation from the perspective of individual firms. The research method is a case study investigation of the impact of sterling overvaluation 1979-82 and 1990-92 on two U.K. companies in the auto and chemical industries in a comparative context with their German rivals. Further, the impact of US$ misalignment in the years 1987-92 on a U.K. exporter highly dependent on the U.S. market is compared with the impact on its German rivals, since both U.K. and German firms were at a disadvantage. In addition, the case is documented of a large U.K. firm which failed during the sterling misalignment which began in 1979. It was found that external financial hedges offered no solution for managing misalignment and that internal financial, operational and strategic hedging is necessary. However, the necessary strategic adjustments only occurred with a lag, if at all. The lag is owing to the suddeness and unanticipated duration of currency misalignment. The two U.K. corporations were forced into retrenchment whereas their German rivals, with a more stable real exchange rate environment and/or a more balanced product/market strategy, gained a competitive advantage. The implications for corporate and public policy are investigated in an E.U. context. Corporations must generate flexibility in their product-market strategies and if they cannot do so, the consequences under prolonged currency overvaluation are serious. It was also found that not only do German firms enjoy a more favourable currency background, but they also benefit from a range of other factors - determinable by public policy - which reduce uncertainty. The reduction in uncertainty from these sources, such as the absence of hostile takeovers, can be of greater importance to the firm than currency stability. Against this background, the conventional self-imposed restriction of the corporate treasury role to financial rather than strategic hedging - and the failure to effectively institutionalize responsibility for proactive strategic currency hedging elsewhere in the firm - will tend to reinforce the higher risk environment facing U.K. firms compared to their German and continental rivals. Thus as far as U.K. firms are concerned, corporations are partial and biased not only in the management of foreign exchange risk but also in the management of total risk.