Bankruptcy Experience and Corporate Hedging

ABSTRACT We examine whether managers’ prior exposure to corporate bankruptcy shapes corporate risk‐management policies. Using detailed executive employment histories and hand‐collected derivative disclosures for a large sample of US public firms, we find that firms led by bankruptcy‐experienced (BE) CEOs are more likely to use cash‐flow hedges and hedge more intensively. Consistent with the “hot stove” hypothesis, exposure to an extreme left‐tail event appears to heighten managers’ sensitivity to downside risk. Several findings support an experience‐based interpretation over managerial sorting or fixed traits: The relation is stronger when the bankruptcy is more recent, when the manager served as CEO of the failed firm, when the failure occurred during a recession, and when career consequences were more severe. Hedging operates as a flexible risk‐management margin; the effect is stronger when managers do not reduce leverage or build cash reserves, suggesting substitution with balance‐sheet conservatism, but complements reductions in investment. The relation weakens under stronger board monitoring, and boards respond to BE CEO appointments by increasing risk‐taking incentives. Above‐predicted hedging is generally associated with higher firm value, but these benefits are significantly weaker when undertaken by BE CEOs; the incremental hedging also attenuates after anti‐recharacterization laws strengthen hedging incentives economy‐wide. At the same time, experience‐driven hedging predicts lower future distress risk and fewer credit downgrades, indicating a trade‐off between downside‐risk reduction and value maximization. The results are robust to firm fixed effects, CEO turnover analyses, matched samples, and controls for managerial characteristics.