Earnings Management and Derivative Hedging with Fair Valuation: Evidence from the Effects of FAS 133

The Accounting Review (Forthcoming)

Fox School of Business Research Paper No. 15-043

Posted: 12 Apr 2014 Last revised: 31 Dec 2016

See all articles by Jongmoo Jay Choi

Jongmoo Jay Choi

Temple University; National Bureau of Economic Research (NBER); Temple University - International Business

Connie X. Mao

Temple University - Fox School of Business and Management; Temple University - Department of Finance

Arun Upadhyay

Florida International University

Date Written: October 21, 2014

Abstract

Barton (2001) and Pincus and Rajgopal (2002) show that earnings management through discretionary accruals and derivative hedging are partial substitutes in smoothing earnings before 1999. In this study, we investigate whether FAS 133 regarding hedge accounting in 2000 has influenced the relative merit of the two earnings smoothing methods. Based on a sample of S&P 500 non-financial firms during 1996-2006, we find that the substitution relation between derivative hedging and discretionary accrual is significantly attenuated after FAS 133 implementation. We also document a significant increase in earnings volatility associated with derivative hedging post-FAS 133. These results are robust to the use of various model and method specifications, as well as controlling for contemporaneous macroeconomic and regulatory shocks. Overall, our results suggest that a material change in an accounting rule regarding derivatives can influence the level and volatility of reported earnings, as well as the method of income smoothing.

Keywords: discretionary accrual, FAS 133, fair value accounting, derivative hedging, income smoothing, corporate risk management, derivative use, earnings management

JEL Classification: G32, M41, M48

Suggested Citation

Choi, Jongmoo Jay and Mao, Connie X. and Upadhyay, Arun, Earnings Management and Derivative Hedging with Fair Valuation: Evidence from the Effects of FAS 133 (October 21, 2014). The Accounting Review (Forthcoming); Fox School of Business Research Paper No. 15-043. Available at SSRN: https://ssrn.com/abstract=2423417 or http://dx.doi.org/10.2139/ssrn.2423417

Jongmoo Jay Choi

Temple University ( email )

Fox School of Business
Temple University
Philadelphia, PA 19122
United States
215-204-5084 (Phone)
215-204-1697 (Fax)

HOME PAGE: http://astro.temple.edu/~jjchoi

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Temple University - International Business ( email )

Philadelphia, PA 19122
United States

Connie X. Mao

Temple University - Fox School of Business and Management ( email )

416 Alter Hall
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Arun Upadhyay (Contact Author)

Florida International University ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

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