Accounting for derivatives and risk management activities. The impact of product market competition

• DOI: https://doi.org/10.1108/IJAIM-05-2015-0028
• Published date: 07 March 2016
• Date: 07 March 2016
• Pages: 82-96
• Author: Abiot Mindaye Tessema
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Accounting for derivatives and

risk management activities

The impact of product market competition

Abiot Mindaye Tessema

Department of Accounting, Zayed University, Abu Dhabi,

United Arab Emirates

Abstract

Purpose – The lessons and merits of changes in the recognition and disclosure of derivative

instruments and hedging activities are still debated and are a major policy issue. Prior studies provide

mixed evidences on the economic consequences of mandatory derivative instruments’ recognition and

disclosure. This paper aims to provide empirical evidence on the impact of mandatory derivative

instruments’ recognition and disclosure on managers’ risk-management behavior. More importantly,

this paper aims to investigate the role of product market competition on the impact of mandatory

derivative instruments’ recognition and disclosure on managers’ risk-management behavior.

Design/methodology/approach – This paper tests the author’s hypotheses using the xed-effects

estimation technique, where it includes rm dummies in all the regressions. This approach enables to

control for unobserved rm effects (xed effects) on rms’ risk-management behavior that are assumed

to be constant through time but vary across rms.

Findings – The author nds that mandatory recognition and disclosure of derivative instruments and

hedging activities, on average, decreases rms’ market rate risk exposure. This nding suggests that

after the implementation of the recognition and disclosure of derivative instruments and hedging

activities required by Statement of Financial Accounting Standards No. 133 (SFAS 133), rms engage

in more prudent risk-management activities to mitigate the potential cost of earnings volatility imposed

by the standard. However, the decrease in market rate risk exposure is lower when the level of product

market competition is higher. This nding is consistent with the idea that the recognition and disclosure

of derivative instruments and hedging activities required by SFAS 133 unintentionally forces rms in

competitive industries to engage in signicant risk-taking. The result suggests that more disclosure in

risk management may change risk-management incentives in undesirable ways if rms face the threat

of entry in their product markets.

Practical/implications – The results provide a new understanding on the role of product market

competition on the effectiveness of mandatory derivative instruments’ recognition and disclosure. The

ndings imply that standard setters should take product market competition into consideration before

making derivative instruments and hedging activities’ recognition and disclosure mandatory for all

rms.

Originality/value – The paper contributes to the accounting literature by providing a new insight

into the moderating role of product market competition in the accounting recognition and disclosure

regulation and rms’ reporting behavior relation. Moreover, the paper extends the current literature on

the effects of SFAS 133 on risk-management activities and sheds light on the impact of accounting

regulations on rms’ real economic behavior.

Keywords Risk management, Disclosure, Derivatives, Recognition, Hedging, Competition

Paper type Research paper

The author thanks the editor of IJAIM and the anonymous referees, Samy Garas, Jerry Spring and

Ghulame Rubbaniy, for their helpful comments.

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

IJAIM

24,1

82

Received 24 May 2015

Revised 3 June 2015

Accepted 8 June 2015

InternationalJournal of

Accountingand Information

Management

Vol.24 No. 1, 2016

pp.82-96

©Emerald Group Publishing Limited

1834-7649

DOI 10.1108/IJAIM-05-2015-0028