Well, the natural consequence of hedging is to reduce earnings volatility.
To illustrate this point, let's consider a firm facing the following situation.
The table on the right-hand side of this page outlines an exaggerated non-linear
tax function where higher and higher tax rates are charged against higher and
higher income levels.
The firm generating only $100,000 in taxable income, pays tax at only 8%.
Yet, a firm that owns $1 million, pays tax on total earnings at a rate of 80%.
It's highly exaggerated.
Now, let's consider two scenarios that the firm faces.
In the first, if it doesn't hedge, then it expects to earn $300,000
of income this year and $700,000 of income the year after.
So, that's one million dollars in total earnings over the two years.
The tax levied on $300,000 this year is $72,000.
And in the next, it'll be $392,000.
So the total tax liability over the two years will be $464,000.
In contrast, if the firm were to hedge, then it could completely smooth its
earnings, thereby generating $500,000 each year, or once again, $1 million in total.
Now, given the non-linear tax function that this firm faces,
the tax levied each year is only $200,000.
So, $400,000 in total.
Hence, the net effect of hedging when faced with the non-linear tax function is
a reduction in taxes paid from $464,000 to only $400,000.