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

Posted: 4 Oct 2001  

Morton Pincus

University of California, Irvine

Shivaram Rajgopal

Columbia Business School

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Abstract

This research investigates whether oil and gas producing firms use abnormal accruals and hedging with derivatives as substitutes to manage earnings volatility. Firms engaged in oil exploration and drilling are exposed to two kinds of risks that can cause earnings volatility: oil price risk and exploration risk. Firms can use abnormal accrual choices and/or derivatives to reduce earnings volatility caused by oil price risk, but cannot directly hedge the operational risk of unsuccessful drilling. Because hedging and using abnormal accruals are costly activities, and because prior research suggests managers do not eliminate all volatility (Haushalter 2000; Barton 2001), we expect that at the margin managers will use these smoothing mechanisms as substitutes to manage earnings volatility. Our results suggest a sequential process whereby managers of oil and gas producing firms first determine the extent to which they will use derivatives to hedge oil price risk, and then, especially in the fourth quarter, manage residual earnings volatility by trading off abnormal accruals and hedging with derivatives to smooth income.

Keywords: Hedging; Derivatives; Income smoothing; Abnormal or discretionary accruals; Oil and gas firms

JEL Classification: M41, M43, G30

Suggested Citation

Pincus, Morton and Rajgopal, Shivaram, The Interaction between Accrual Management and Hedging: Evidence from Oil and Gas Firms. The Accounting Review, January 2002. Available at SSRN: https://ssrn.com/abstract=280683

Morton P.K. Pincus (Contact Author)

University of California, Irvine ( email )

Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)

Shivaram Rajgopal

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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