• The Impact of Financial Derivative Usage on Earnings Attributes and Earnings Informativeness

Abstract

This study investigates the impact of financial derivatives usage on earnings attributes and earnings informativeness. First, we examine the relation between the derivatives usage and several attributes of earnings: accrual quality, persistence, predictability, and smoothness. After controlling for innate determinants of the earnings attributes, empirical results indicate that firms hedged with derivatives can smooth earnings volatility, enhance earnings predictability and persistence, and improve accrual quality. This suggests that firms hedged with derivatives can improve earnings attributes. Second, we use future earnings response coefficient, denoted by FERC, to capture hedge firms’ earnings informativeness. We find that firms with higher hedge ratio have high FERC, suggesting that derivatives usage for hedging can improve current earnings informative about future earnings. These findings are robust to controlling for self-selection bias in earnings attribute model, to using alternative proxies for the earnings attributes, and to controlling for potentially omitted correlated variables in earnings informativeness model.

Keywords: Derivatives, Hedge, Earnings attributes, Earnings informativeness