Management's disclosure of hedging activity: An empirical investigation of analysts’ and investors’ reactions

Abstract

Purpose

This study aims to examine how market participants changed the way they process earnings information after learning of the implementation of hedging activities.

Design/methodology/approach

Using a sample of derivative user and non‐user firms, this study empirically compares earnings predictability, forecast revision behavior, and the earnings response coefficients before and after the disclosure of sustained hedging activity.

Findings

The findings indicate that analysts’ forecast accuracy increased and that unexpected earnings were incorporated into subsequent earnings forecasts to a greater extent subsequent to disclosure of sustained hedging activity. Additionally, the findings indicate an increase in the earnings‐return relation in the hedging activity period.

Research limitations/implications

This evidence empirically supports the claim that, when a company communicates that hedging activities have been started, market participants are better able to forecast earnings and view subsequent earnings announcements as providing greater information about future earnings. The results may be understated due to the minimal disclosures required during the sample period. Future research could revisit these tests for the SFAS 133 time period as a way of evaluating the usefulness of more detailed disclosures.

Practical implications

The models used in the tests of forecast revisions and earnings response coefficients could easily be adapted to other settings where the research question compares different time periods.

Originality/value

This study adds to the empirical evidence regarding the effects of hedging activity by providing direct evidence of analysts’ use of and investors’ reactions to earnings surprises following the disclosure of the implementation of hedging activities.

Citation

Reynolds‐Moehrle, J. (2005), "Management's disclosure of hedging activity: An empirical investigation of analysts’ and investors’ reactions", International Journal of Managerial Finance, Vol. 1 No. 2, pp. 108-122. https://doi.org/10.1108/17439130510600820