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How fair-value accounting can influence firm hedging

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  • Leif Beisland
  • Dennis Frestad

Abstract

The potential influence of accounting regulations on hedging strategies and the use of financial derivatives is a research topic that has attracted little attention in both the finance and the accounting literature. However, recent surveys suggest that company hedging can be substantially influenced by the accounting for financial instruments. In this study, we illustrate not only why but also how the accounting regulations may affect hedging behavior. We find that under mark-to-market accounting, most firms concerned with earnings smoothness adopt myopic hedging strategies relative to the benchmark, cash flow hedging. The specific influence of the accounting regulations depends on market and firm-specific characteristics, but, in general, the firms dramatically reduce the extent of hedging addressing price risk in future accounting periods. We illustrate that the change in hedging behavior significantly dampens the increase in earnings volatility stemming from fair value accounting of derivatives. However, the adjusted hedging strategies may substantially increase the firms’ cash flow volatility. Copyright Springer Science+Business Media New York 2013

Suggested Citation

  • Leif Beisland & Dennis Frestad, 2013. "How fair-value accounting can influence firm hedging," Review of Derivatives Research, Springer, vol. 16(2), pages 193-217, July.
    • Handle: RePEc:kap:revdev:v:16:y:2013:i:2:p:193-217
    DOI: 10.1007/s11147-012-9084-y
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    More about this item

    Keywords

    Cash-flow hedging; Earnings hedging; Earnings volatility; Unhedgeable risk; Hedgeable risk; Fair value accounting; G18; G19; M41; M48;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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