Managing Exchange Rate Exposures through Related Party Transactions in the Internalized Market

Purpose - This study empirically analyzes if and how firms utilize the beneficial features of foreign related party transactions (RPTs) Design/Methodology - Using a dataset of Korean firms from 2011 to 2021, we compile data on firm RPTs, categorize them by region and direction of cash flows, and estimate firm exchange exposure using daily returns and exchange rate changes. We then analyze the impact of the RPTs on firm exchange exposure and test whether this impact is affected by the geographic distribution of affiliates and the degree of exchange exposure. Findings - We document the following main results. First, firms engaging in foreign expense or payment RPTs command significantly lower exchange exposures than firms engaging in no such transactions. Second, the effectiveness of managing exposures is notably higher for firms with a broad network of foreign-related partners across diverse regions. Third, foreign expense RPTs have a greater effect on firms with a higher level of foreign exchange exposure. Originality/value - With new evidence of active firm use of RPTs in managing exchange exposures, our study contributes to exchange risk management literature by expanding its theoretical and practical scopes to unexplored channel of RPTs.