Accepted by Jeffrey Callen. This paper is based on my dissertation completed at the University of Arizona. I appreciate the input of Ben Ayers, Linda Bamber, and my dissertation committee: Dan Dhaliwal (chair), Dan Bens, Sandy Klasa, Bill Schwartz, and Mark Trombley. I am also grateful for the many helpful comments and suggestions of two anonymous reviewers, Andy Call, Jeff Callen, Patricia Dechow, Pat Hopkins, Jack Hughes, Patricia O'Brien, Catherine Schrand, Terry Shevlin, Richard Sloan, and Eric Yeung. Finally, I thank the participants of the conference at the 2010 Financial Accounting and Reporting Section (FARS) mid-year meeting, as well as workshop participants at the Universities of Arizona, California-Berkeley, California-Los Angeles, Georgia, Michigan, Missouri, Pennsylvania (Wharton), and Washington, as well as Carnegie Mellon University, Dartmouth College, and Indiana University. I gratefully acknowledge financial support from the Deloitte Foundation's Doctoral Fellowship Program, and excellent research assistance from Cameron Aycock and Adam Tarpley.
The Fair Value of Cash Flow Hedges, Future Profitability, and Stock Returns†
Version of Record online: 29 SEP 2014
Contemporary Accounting Research
Volume 32, Issue 1, pages 243–279, Spring 2015
How to Cite
Campbell, J. L. (2015), The Fair Value of Cash Flow Hedges, Future Profitability, and Stock Returns. Contemporary Accounting Research, 32: 243–279. doi: 10.1111/1911-3846.12069
- Issue online: 12 MAR 2015
- Version of Record online: 29 SEP 2014
- Accepted manuscript online: 4 OCT 2013 09:02AM EST
- Deloitte Foundation's Doctoral Fellowship Program
The SEC and FASB recently expressed concerns that investors do not fully assimilate all of the information provided by complex and incomplete derivatives and other comprehensive income (OCI) disclosures. My evidence supports these concerns. Specifically, I examine the information content of unrealized cash flow hedge gains/losses for future profitability and stock returns. An unrealized gain on a cash flow hedge suggests that the price of the underlying hedged item (i.e., commodity price, foreign currency exchange rate, or interest rate) moved in a direction that will impair the firm's profits after the hedge expires. Consequently, I find that unrealized cash flow hedge gains/losses are negatively associated with future gross profit after the firm's existing hedges have expired. This association only holds after the firm has reclassified its hedges into earnings, and is weaker for firms that can pass input price changes on to their customers. Finally, investors do not immediately price the cash flow hedge information. Instead, investors appear surprised by future realizations of gross margin, consistent with the view that complex and incomplete disclosures delay pricing. These results are relevant to policymakers involved in the current FASB and IASB project designed to simplify the accounting and disclosure for derivatives and, in particular, cash flow hedges.