The Fair Value of Cash Flow Hedges, Future Profitability, and Stock Returns

62 Pages Posted: 1 Aug 2009 Last revised: 20 Sep 2013

See all articles by John L. Campbell

John L. Campbell

University of Georgia - J.M. Tull School of Accounting

Date Written: July 11, 2013

Abstract

The SEC and FASB recently expressed concerns that investors do not fully assimilate all of the information provided by complex and incomplete derivatives and other comprehensive income (OCI) disclosures. My evidence supports these concerns. Specifically, I examine the information content of unrealized cash flow hedge gains/losses for future profitability and stock returns. An unrealized gain on a cash flow hedge suggests 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 impair the firm’s profits after the hedge expires. Consequently, I find that unrealized cash flow hedge gains/losses are negatively associated with future gross profit after the firm’s existing hedges have expired. This association only holds after the firm has reclassified its hedges into earnings, and is weaker for firms that can pass input price changes on to their customers. Finally, investors do not immediately price the cash flow hedge information. Instead, investors appear surprised by future realizations of gross margin, consistent with the view that complex and incomplete disclosures delay pricing. These results are relevant to policymakers involved in the current FASB and IASB project designed to simplify the accounting and disclosure for derivatives and, in particular, cash flow hedges.

Keywords: Fair value, disclosure, market valuation, cash flow hedges, industry concentration, other comprehensive income

JEL Classification: M40, M41, M48

Suggested Citation

Campbell, John L., The Fair Value of Cash Flow Hedges, Future Profitability, and Stock Returns (July 11, 2013). AAA 2010 Financial Accounting and Reporting Section (FARS) Paper, Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1441684 or http://dx.doi.org/10.2139/ssrn.1441684

John L. Campbell (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706.542.3595 (Phone)
706.542.3630 (Fax)

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