Hedging, Hedge Accounting, and Earnings Predictability

Forthcoming, 'Review of Accounting Studies'

61 Pages Posted: 16 Feb 2021 Last revised: 19 Mar 2021

See all articles by Tharindra Ranasinghe

Tharindra Ranasinghe

American University

Shiva Sivaramakrishnan

Rice University

Lin Yi

University of Houston, Clear Lake

Date Written: March 18, 2021

Abstract

Studies suggest that, pursuant to the implementation of SFAS 133, even sophisticated users of financial statements find it difficult to comprehend earnings implications of hedging derivatives. Moreover, due to stringent hedge accounting requirements under these standards, many economic hedges do not qualify for hedge accounting and are deemed “ineffective” for financial reporting purposes. Motivated by these considerations, we investigate the impact of hedging on earnings predictability by analyzing hand-collected hedging data from two industries that extensively use derivatives to manage price risks: the oil-and-gas exploration and production industry and the airline industry. In contrast to extant evidence, we find that overall hedging derivatives improve income predictability and increase (decrease) analysts’ forecast accuracy (dispersion). We also show hedges deemed ineffective for hedge accounting can increase earnings volatility and significantly impair earnings predictability. This finding lends support to concerns expressed by some corporate managers and industry experts against stringent hedge accounting requirements.

Keywords: Financial analysts, earnings forecasts, derivatives, hedging, hedge ineffectiveness

Suggested Citation

Ranasinghe, Tharindra and Sivaramakrishnan, Shiva and Yi, Lin, Hedging, Hedge Accounting, and Earnings Predictability (March 18, 2021). Forthcoming, 'Review of Accounting Studies', Available at SSRN: https://ssrn.com/abstract=3770487 or http://dx.doi.org/10.2139/ssrn.3770487

Tharindra Ranasinghe (Contact Author)

American University ( email )

United States

Shiva Sivaramakrishnan

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

Lin Yi

University of Houston, Clear Lake ( email )

2700 Bay Area Blvd. Box 42
Houston, TX 77058
United States

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