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Does Hedge Accounting Complexity Influence the Effectiveness of Firms’ Hedging Activities?

Working Paper
Complexity in applying financial accounting standards can have real operational effects if firms alter their actions in the face of increased reporting costs. The authors examine whether the introduction of new standards (ASU 2017-12) designed to reduce compliance burden and better align hedge accounting rules with risk management practices affected actual derivatives usage, and more importantly, operational outcomes tied to hedging. Using difference-in-differences tests the authors show that firms that adopt the ASU designate more of their derivatives as hedges, while also exhibiting less exposure to firm level risks. In addition, firms’ cash flow volatility, earnings volatility, and bid-ask spreads decline upon ASU adoption. Also, ASU adopting firms increase their use of debt while investing more. Their results suggest, with both statistical and economic significance, that a reduction in complexity in applying financial accounting derivative rules led to greater hedge accounting use, more actual hedging, and reduced financing and investment frictions.
Faculty

Professor of Accounting and Control

Professor of Accounting and Control