Do sophisticated investors use the information provided by the fair value of cash flow hedges?

Do sophisticated investors use the information provided by the fair value of cash flow hedges? An unrealized gain on a cash flow hedge implies that the price of the underlying hedged item (i.e., commodity price, foreign currency exchange rate, or interest rate) moved in a direction that will negatively affect the firm’s profits after the hedge expires. Prior research shows that unrealized gains/losses on cash flow hedges are negatively associated with future earnings and that investors’ expectations, as reflected in stock prices, do not appear to anticipate this association. We provide further evidence on this mispricing by examining whether financial analysts understand the future earnings effects of cash flow hedges. We find three main results: (1) analysts do not correctly incorporate unrealized cash flow hedging gains and losses into their 2- and 3-year-ahead earnings forecasts, (2) analysts correct their errors after the hedges have largely expired and investors correct their mispricing at this time, and (3) analysts and investors can better process cash-flow-hedge information when managers provide forecasts. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Do sophisticated investors use the information provided by the fair value of cash flow hedges?

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Publisher
Springer Journals
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-015-9318-y
Publisher site
See Article on Publisher Site

Abstract

An unrealized gain on a cash flow hedge implies that the price of the underlying hedged item (i.e., commodity price, foreign currency exchange rate, or interest rate) moved in a direction that will negatively affect the firm’s profits after the hedge expires. Prior research shows that unrealized gains/losses on cash flow hedges are negatively associated with future earnings and that investors’ expectations, as reflected in stock prices, do not appear to anticipate this association. We provide further evidence on this mispricing by examining whether financial analysts understand the future earnings effects of cash flow hedges. We find three main results: (1) analysts do not correctly incorporate unrealized cash flow hedging gains and losses into their 2- and 3-year-ahead earnings forecasts, (2) analysts correct their errors after the hedges have largely expired and investors correct their mispricing at this time, and (3) analysts and investors can better process cash-flow-hedge information when managers provide forecasts.

Journal

Review of Accounting StudiesSpringer Journals

Published: Mar 6, 2015

References

  • Does earnings guidance affect market returns? The nature and information content of aggregate earnings guidance
    Anilowski, C; Feng, M; Skinner, D
  • Analyst earnings forecast revisions and the pricing of accruals
    Barth, M; Hutton, A
  • Accounting-based stock price anomalies: separating market inefficiencies from risk
    Bernard, V; Thomas, J; Wahlen, J
  • Do analysts and auditors use information in accruals?
    Bradshaw, M; Sloan, R; Richardson, S
  • The superiority of analyst forecasts as measures of expectations: evidence from earnings
    Brown, L; Rozeff, M
  • The fair value of cash flow hedges, future profitability, and stock returns
    Campbell, JL
  • Insider trading and voluntary disclosures
    Cheng, Q; Lo, K
  • Disclosure, liquidity, and the cost of capital
    Diamond, D; Verrechia, R
  • Industry costs of equity
    Fama, E; French, K

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