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The Effect of Mandatory Disclosure on Market Inefficiencies: Evidence from Statement of Financial Accounting Standard Number 161

55 Pages Posted: 15 Sep 2017 Last revised: 11 Oct 2017

John L. Campbell

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

Urooj Khan

Columbia Business School - Accounting, Business Law & Taxation

Spencer Pierce

Florida State University - College of Business

Date Written: September 12, 2017

Abstract

Prior research finds that unrealized gains/losses on cash flow hedges are negatively associated with future earnings. However, equity investors and analysts fail to anticipate this association. These studies speculate that the mispricing is due to poor derivative disclosures. In this study, we examine whether the enhanced mandatory derivatives disclosures set forth in FAS 161 improve users’ understanding of firms’ hedging activities, and offer two main findings. First, we find no evidence of mispricing after FAS 161, suggesting that enhanced mandatory derivative disclosures helped correct investors’ understanding of the implication of unrealized cash flow hedge gains/losses for future firm performance. Second, we find that analysts’ forecasts exhibit less error related to cash flow hedges after FAS 161, suggesting that these enhanced disclosures improve the information environment for sophisticated information intermediaries. In additional analysis, we find that the reduction in mispricing holds regardless of a firm’s institutional ownership level, suggesting that the additional disclosures appear to have benefited all investors regardless of their sophistication. Overall, our results suggest that the enhanced mandatory derivative disclosures required by FAS 161 improved investors’ and analysts’ understanding of the effects of derivative and hedging activities on future firm performance and firm value.

Keywords: Derivatives; Mandatory Disclosure; Market inefficiency; Effectiveness of Regulation

Suggested Citation

Campbell, John L. and Khan, Urooj and Pierce, Spencer, The Effect of Mandatory Disclosure on Market Inefficiencies: Evidence from Statement of Financial Accounting Standard Number 161 (September 12, 2017). Columbia Business School Research Paper No. 17-94. Available at SSRN: https://ssrn.com/abstract=3035887

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)

Urooj Khan

Columbia Business School - Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

Spencer Pierce

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States

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