Shedding light on foreign currency cash flow hedges: transparency and the hedging decision

Abstract

Utilizing firms in the S&P 500, we study whether greater transparency in the reporting of other comprehensive income (OCI) items, as mandated by ASU 2011-05, resulted in a reduction in information asymmetry, a change in the value relevance of this information, or a change in hedging practice. Our results show that while transparent reporting reduced information asymmetry, firms that engage in cash flow hedging do have greater information asymmetry than their counterparts that do not hedge. We find evidence that investors penalize firm value for greater volatility of OCI relative to net income volatility when reported transparently. When permitted, managers were able to mitigate the negative impact by reporting OCI only in the Statement of Shareholders’ Equity. We conclude that managers’ concerns regarding potential confusion surrounding OCI volatility following more prominent reporting led to changes in hedging behavior. After transparent reporting, we find a reduced likelihood of foreign currency cash flow (FXCF) hedges and a reduced level of FXCF hedging among firms experiencing the greatest volatility of unrealized hedging gains and losses.