Large tariff cuts and corporate hedging: Evidence from interest rate swaps

• Large U.S. tariff cuts increase domestic firms’ use of interest rate swaps, shifting debt from fixed to floating rates. • The effect operates through intensified product market competition and lower expected borrowing costs, increasing incentives to preserve financial flexibility. • Strongest responses are observed for firms near the industry’s technological core, in highly substitutable markets, and with low cash reserves. • Results establish a novel link between trade policy shocks, corporate risk management, and firms’ debt structure choices. We examine how trade policy shocks affect firms’ interest rate hedging and debt structure. Using plausibly exogenous large U.S. tariff cuts from 1992–2015 as industry-level shocks, we find that exposed firms increase their use of interest rate swaps, converting fixed-rate debt into floating obligations. Drawing on real options and corporate hedging frameworks, we argue that large tariff cuts intensify competition and lower expected borrowing costs through reduced import prices and input costs, raising underinvestment risk while increasing incentives to maintain financial flexibility. Firms dynamically reoptimize their debt composition to capture expected savings and secure funding for time-sensitive projects. Effects are strongest among firms close to their industry’s technological core, in highly substitutable markets, and with low cash buffers. Our findings establish a novel link between international trade policy, corporate risk management, and debt structure.