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The behavior of managers in initiating a derivatives market position brings to the surface an interesting phenomenon: sometimes managers initiate a position in derivatives markets (i.e., futures and options markets) and sometimes they do not, even though the price volatility of the underlying asset has not changed. The current (hedging) models might explain the phenomenon of derivatives position-initiating behavior by assuming changes in the manager's risk attitude and in the volatility of the underlying asset. However, this explanation is not in line with the literature that suggests that risk attitude in a particular domain does not show strong changes within a short time frame. In this paper we try to solve this puzzle by providing a conceptual model that is able to explain the manager's futures contract initiation behavior. The psychological reference price and the futures market price level at the manager's decision moment play a key role in this model. The model is able to explain futures initiation behavior without assuming changing risk attitudes or changing price volatility. Using data from experiments obtained from personal computer-guided interviews conducted with 450 managers, the proposed model is tested with logistic regression on choice probabilities. The manager's risk attitude, the ratio of the futures price level to the manager's psychological reference price and the interaction between them, appear to explain the manager's behavior in initiating a futures position.

Recently, growing attention has been paid to the factors that explain why firms use derivatives as risk reduction instruments. Carter and Sinkey (1998), Géczy, Minton, and Schrand (1997), Howton and Perfect (1998), Koski and Pontiff (1999), Lee and Hoyt (1997), Mian (1996), Nance, Smith, and Smithson (1993), Pennings and Leuthold (2000), Schrand and Unal (1998), Smith and Stulz (1985), Tufano (1996) and Visvanathan (1998) among others have analyzed the determinants of corporate derivative use.1 These studies provide valuable insight into the characteristics of corporations that are associated with the decision to use derivatives. Several factors, such as the firm's risk exposure, its growth opportunity, the level of wealth, managerial risk aversion, financial distress costs, and the accessibility to financing appear to influence the decision of a corporation to adapt derivatives to their risk management toolbox. However, gaining insight into why firms use derivatives as risk management tools does not explain the manager's decision whether or not to enter the derivatives market in a concrete choice situation. 2 In this paper, we focus on futures as an example of a derivative used as a hedging tool. 3 We will focus our attention on the situation in which managers are deciding whether or not to initiate a position in the futures market. In such a concrete choice situation, the manager has two options: to initiate a futures position or not to initiate a position (the latter could mean delaying the initiation of the futures position). The behavior of a manager in such a concrete choice situation will be referred to as “the manager's behavior in initiating a futures position”. The phenomenon of managers sometimes deciding to initiate a position in the futures market and sometimes deciding not to (e.g., whether or not the manager “pulls the trigger”), without a change in the volatility of the risky asset or commodity, is often assumed to be attributed to a change in the manager's risk attitude. Several articles concerning portfolio selection use this explanation (Mehra & Prescott, 1985; Hagiwara & Herce, 1997). Yet, in the literature it has been argued that risk attitude in a particular domain does not change in a short time frame (March & Shapira, 1992; Schoenmaker, 1993; Smidts, 1997; Weber & Milliman, 1997).4 The phenomenon of managers sometimes deciding to initiate a futures position and sometimes deciding not to, often occurs in a relatively short time span of, let us say, several minutes. As the effects of the fundamental factors that influence risk attitude (such as age) span a much longer period of time, we might expect risk attitude to be constant. If this is the case, then why do managers either initiate futures positions or do not initiate them, while volatility, and hence their risk exposure, remains unchanged? Obviously the decision to initiate a futures position depends on the riskiness of the underlying commodity that the manager wishes to hedge. The manager's response to the risk exposure depends on his or her risk attitude. The decision to initiate a futures position also depends on the futures price level. So, on the one hand risk attitude will play a role in a concrete choice situation, as risk aversion is the primary motivation for risk reduction behavior (hereafter referred to as hedging behavior), and on the other hand the futures price will play a role too. What, then, is a “good” futures price? Or, put differently, what is a price that will generate the desired financial performance and hence a price at which the producer wishes to initiate a futures position? It has been shown that decision-makers use psychological reference prices to evaluate price levels (March, 1988; Payne, Laughhunn, & Grum, 1980; Puto, 1987; Qualls & Puto, 1989; Siegel, 1957). In this research, the manager's psychological reference price is defined as a price (or price scale) in the manager's memory that serves as a basis for judging or comparing prices (Grewal, Monroe, & Krishnan, 1998). So, it seems that in a concrete choice situation in which the manager has to decide whether or not to initiate a futures position, risk attitude on the one hand and the manager's reference price compared to the actual futures price on the other hand play a role. In this paper, we try to gain insight into the managers' behavior in initiating a futures position by examining the relationships among risk attitudes, futures price levels and reference prices. The remainder of the paper is structured as follows. First, in Section 2, we introduce a conceptual model that links risk attitude, the manager's reference price, and the price level in the futures market to the manager's behavior in initiating a futures position. After the presentation of the research method and the operationalization of the model in Section 3, the model is tested in Section 4. Data obtained from 450 owner-managers of agricultural enterprises by means of computer-assisted personal interviews constitute the input for this part of the research. We conclude with an evaluation of the study and make some suggestions for further research in Section 5.

Recently, the literature has paid attention to the use of derivatives in a business of conduct context. Géczy et al. (1997), Howton and Perfect (1998), Koski and Pontiff (1999), Lee and Hoyt (1997), Mian (1996), Nance et al. (1993), Schrand and Unal (1998) and Tufano (1996) provide insight into the corporate characteristics associated with the decision to add derivatives to the corporation's risk management tools. This paper investigates how a manager decides to initiate a futures position in a concrete choice situation (e.g. whether or not the manager “pulls the trigger”). Such behavior might, for example, be explained using the mean–variance models (Robinson & Barry, 1987) which assumes a change in risk attitude and volatility, something that is unlikely to occur in a short time span. Our results show that the managers' futures position initiation behavior can be explained by the level of risk attitude (treated as a variable that does not change within a short time frame) and the ratio of the futures price level to the manager's reference price. Risk aversion combined with a ratio larger than one increases the probability of a manager initiating a futures position and vice versa. Moreover, these two key components interact. That is, a risk-averse hedger will be more inclined to take a futures position than a less risk-averse decision-maker (or a risk-seeking decision-maker). This behavior, the willingness to take a futures position, will be more prominent when the ratio of the futures price level to the manager's reference price is larger than one.8 Our results show how the manager's reference price and futures price level may be incorporated in models that focus on concrete hedging choice behavior (as opposed to models that focus on how futures become part of the corporate business of conduct). The interaction between the ratio of the futures price level to the manager's reference price on the one hand and risk attitude on the other may be interpreted in an interesting way. One may view this interaction as risk attitude, the primary force behind hedging, being weighted by the ratio of the futures price level to the manager's reference price. If we investigate futures initiation behavior without considering the ratio of the futures price level to the reference price, it will lead us to conclude that risk attitude changes are the driving force behind this type of behavior, but it is unlikely for risk attitude to change over a short span of time. Thus, failure to account for the reference price will mask the actual role of risk attitude. For further research of this type it seems valuable to combine accounting data with experimental data. Through experiments the decision behavior of managers in concrete choice situations may be based on evidence about how managers actually behave, something not always present in accounting data. Our findings suggest several directions for further research. First, our study may be replicated within other financial services, such as speculation services, and may be replicated for other derivatives. Secondly, it would seem interesting to include the concepts proposed in this paper in other domains of finance where the manager's reference price might play a role. An example of such a domain is the research dealing with the equity puzzle, where the equity risk premium in a representative agent setting cannot be explained satisfactorily without introducing implausibly heightened levels of risk aversion (Cecchetti, Lam, & Mark, 1993; Kandel & Stambaugh, 1990; Mehra & Prescott, 1985). Including the concept of price levels and reference prices in this stream of research would be an interesting avenue to explore.