Hedging, hedge accounting, and earnings predictability

Tharindra Ranasinghe (), Konduru Sivaramakrishnan () and Lin Yi ()
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Tharindra Ranasinghe: American University
Konduru Sivaramakrishnan: Rice University
Lin Yi: University of Houston – Clear Lake

Review of Accounting Studies, 2022, vol. 27, issue 1, No 2, 35-75

Abstract: 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 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11142-021-09595-8

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