| This paper examines the impact of Statement of Financial Accounting Standard No. 133 (SFAS 133), "Accounting for derivative instruments and hedging activities", on corporate risk-management behavior. SFAS 133 requires companies to recognize fair values of derivative instruments in the balance sheet and changes in fair values in the income statement; however, it provides preferential accounting treatment for derivative instruments that effectively hedge the underlying business risk. Hedge accounting allows only the ineffective hedging or speculative positions to be reflected in current period earnings. Thus, I hypothesize that the effect of the standard on firms' risk-management activities varies depending on the hedging effectiveness of their derivative instruments. I designate a new derivative user as an effective hedger if its risk exposures decreased relative to non-users after the initiation of the derivatives program and as an ineffective hedger ("speculator") otherwise. The empirical results show that risk exposures related to interest-rate, foreign exchange-rate, and commodity price decrease significantly for speculators but not for hedgers after the adoption of SFAS 133. Consistent with the decrease in risk exposures, I find that the volatility of cash flows for speculators also decreases significantly relative to hedgers while the volatility of earnings remains unchanged for both groups. Overall, the evidence suggests that SFAS 133 has discouraged firms' speculative use of derivative instruments. |
