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The Interaction between Accrual Management and Hedging: Evidence from Oil and Gas Firms

Shivaram Rajgopal

Columbia Business School

Morton Pincus

University of California, Irvine

February 2000

This research investigates whether discretionary accrual decisions and use of derivative instruments areindependent of each other. We examine firms primarily engaged in oil exploration and drilling since we can identify two kinds of risks to which these firms are exposed that can cause earnings volatility. These are oil price risk and exploration risk. While firms can hedge oil price risk with derivative instruments, markets do not exist in which firms can hedge the operational risk of unsuccessful drilling. Discretionary accrual choices can be used to reduce variability in earnings induced by the exploration risks and both discretionary accruals and hedging can reduce earnings variability associated with oil price fluctuations. We find that firms in our sample do not hedge all oil price risk they face, but instead appear to want to achieve some benchmark level of earnings volatility. In our primary analysis, we separate the decision to hedge oil price risk from the extent of hedging, and simultaneously consider the extent of hedging and the extent of smoothing with discretionary accruals. The results indicate that firms are more likely to hedge the higher the level of exploration risk they face. Moreover, after controlling for other determinants of hedging and discretionary accrual smoothing, we find that the extent of hedging and the extent of discretionary accrual smoothing are substitutes.

Note: Previously titled: The Interaction of Accounting Policy Choice and Hedging: Evidence from Oil and Gas Firms

Number of Pages in PDF File: 55

JEL Classification: G31, G32, M41, M43

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Date posted: August 26, 1999  

Suggested Citation

Rajgopal, Shivaram and Pincus, Morton, The Interaction between Accrual Management and Hedging: Evidence from Oil and Gas Firms (February 2000). Available at SSRN: https://ssrn.com/abstract=171393 or http://dx.doi.org/10.2139/ssrn.171393

Contact Information

Shivaram Rajgopal (Contact Author)
Columbia Business School ( email )
3022 Broadway
New York, NY 10027
United States

Morton P.K. Pincus
University of California, Irvine ( email )
Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)
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