Hedge Accounting and Firms’ Future Investment Spending

Abstract

Finance theory argues that hedging helps firms overcome underinvestment problems. We provide evidence that this only applies to derivatives designated for hedge accounting, implying that only effective hedges are designated as required under accounting standard ASC 815. Thus, the FASB has installed an effective signaling device for stakeholders about the success of firms’ hedging programs. However, firms using complex hedging strategies seemingly cannot designate some of their successful derivatives due to the often criticized strict criteria for hedge accounting. Our findings provide relevant implications for practitioners and standard-setters, particularly in current uncertain times where risk management plays an important role.

Keywords: derivatives, hedging, hedge accounting, underinvestment, investment spending