Hedge Accounting and Firms’ Future Investment Spending

This study explores the effectiveness and consequences of hedge accounting rules under ASC 815 by investigating the relationship between derivative designation and future investments. Finance theory argues that hedging helps firms to overcome underinvestment problems, as it reduces the probability of liquidity shortfalls. We argue that this association holds only for derivatives designated for hedge accounting, which requires the fulfilment of strict effectiveness criteria. We find that only designated derivative assets are positively associated with future investments implying that the regulations under ASC 815 are generally implemented correctly and that the FASB has installed an effective signaling device about the success of firms’ hedging programs. However, firms using portfolio hedging strategies seemingly cannot designate some of their successful derivatives due to the often criticized restriction of hedge accounting to hedges at transaction-level. Our findings should interest researchers, practitioners and financial standard-setters, particularly in times when derivative use becomes increasingly important.