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Hedge accounting and investors’ view of FX risk

Hedge accounting and investors’ view of FX risk PurposeThis paper aims to examine the foreign exchange (FX) risk effects of cash flow hedge accounting (HA). To the extent the HA qualification criteria and detailed documentation give investors confidence that FX derivatives effectively hedge risk, market-assigned FX risk premiums will be lower for firms using cash flow HA.Design/methodology/approachProbit analyses rely on the HA designation to examine the decision to use cash flow HA. Primary analyses test the hypothesized relationship between the magnitude of FX risk premiums and such HA use. Additional analyses allow for the interaction between cash flow HA use and the extent of FX derivatives use.FindingsHypothesis tests indicate that the magnitude of the FX risk premium is, on average, lower for firms designated as effective cash flow hedgers. In additional tests, the evidence suggests that the market assigns a lower FX risk premium to firms using a higher level of FX derivatives as effective cash flow hedges.Practical implicationsThe findings suggest that cash flow HA provides risk-relevant information to investors. Such positive effects of HA on investors’ understanding of risk management may guide US accounting regulators in their efforts to improve HA. Corporate treasurers also may benefit from these insights into evaluating the use of HA.Originality/valueResponding to the call for research on the risk relevance of cash flow HA, this paper merges the HA literature with the FX risk management literature to directly examine the relationship between HA use and FX risk premiums for manufacturing firms. The authors take an innovative approach using FX rates to which each firm is most exposed and provide evidence consistent with the argument that this approach is helpful in understanding both the decision to use cash flow HA and the effect of such HA use on market-assigned FX risk premiums. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Accounting and Information Management Emerald Publishing

Hedge accounting and investors’ view of FX risk

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
1834-7649
DOI
10.1108/IJAIM-10-2017-0121
Publisher site
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Abstract

PurposeThis paper aims to examine the foreign exchange (FX) risk effects of cash flow hedge accounting (HA). To the extent the HA qualification criteria and detailed documentation give investors confidence that FX derivatives effectively hedge risk, market-assigned FX risk premiums will be lower for firms using cash flow HA.Design/methodology/approachProbit analyses rely on the HA designation to examine the decision to use cash flow HA. Primary analyses test the hypothesized relationship between the magnitude of FX risk premiums and such HA use. Additional analyses allow for the interaction between cash flow HA use and the extent of FX derivatives use.FindingsHypothesis tests indicate that the magnitude of the FX risk premium is, on average, lower for firms designated as effective cash flow hedgers. In additional tests, the evidence suggests that the market assigns a lower FX risk premium to firms using a higher level of FX derivatives as effective cash flow hedges.Practical implicationsThe findings suggest that cash flow HA provides risk-relevant information to investors. Such positive effects of HA on investors’ understanding of risk management may guide US accounting regulators in their efforts to improve HA. Corporate treasurers also may benefit from these insights into evaluating the use of HA.Originality/valueResponding to the call for research on the risk relevance of cash flow HA, this paper merges the HA literature with the FX risk management literature to directly examine the relationship between HA use and FX risk premiums for manufacturing firms. The authors take an innovative approach using FX rates to which each firm is most exposed and provide evidence consistent with the argument that this approach is helpful in understanding both the decision to use cash flow HA and the effect of such HA use on market-assigned FX risk premiums.

Journal

International Journal of Accounting and Information Management – Emerald Publishing

Published: Aug 5, 2019

References

  • Foreign exchange exposure of ‘domestic’ corporations
  • Effects of SFAS 133 on the risk relevance of banks’ derivative exposure
  • Exchange rate exposure, hedging, and the use of foreign currency derivatives
  • Crossing the lines: the conditional relation between exchange rate exposure and stock returns in emerging and developing markets
  • Resolving the exposure puzzle: the many facets of exchange rate exposure
  • Other comprehensive income: a review and directions for future research