Extant literature is mixed as to whether gains and losses of cash flow hedges reported in other comprehensive income (OCI) convey information about firms’ subsequent periods’ financial performance and suggests that market participants are unable to understand these information signals (if any). We posit that this issue is more nuanced because hedging gains and losses provide opposite signals with respect to unhedged versus hedged positions of the underlying item. Further, separating the OCI disclosures between the fair value changes of outstanding hedges and reclassification adjustments of settled hedges becomes important because it is the outstanding hedges that impact future performance. Examining OCI reporting of cash flow hedges by U.S. Oil and Gas Exploration and Production firms after measuring the extent of hedging and explicitly accounting for the above factors, we find that these disclosures are informative of the following year’s earnings and operating cash flows. Moreover, both financial analysts and investors appear to understand the information signals provided by fair value changes of outstanding hedges regarding unhedged and hedged positions of future oil and gas production. Additionally, we find the introduction of SFAS 161 and the issuance of management earnings forecasts further enhance this understanding. Overall, our findings suggest that disclosures provided under current hedge accounting standards are informative to capital market participants.
| Speaker: | Dr Tharindra Ranasinghe Associate Professor, American University |
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