The economic effects of SFAS 133 on hedging activities of firms: Evidence from oil and gas producers

This dissertation investigates the association between the Statement of Financial Accounting Standards (SFAS) No. 133 (FASB (1998)), Accounting for Derivatives and Hedging Activities and firms' hedging activities. Critics of SFAS 133 argue that the standard would drive firms to reduce their hedging activities. This criticism stems from the two main changes to the accounting for derivatives brought about by SFAS 133. First, all derivatives must be recognized at fair value. Second, hedge accounting is more difficult to apply. As a result of these two changes, firms may reduce their hedging activities post SFAS 133 to alleviate the impact of the changes in fair value of derivatives on short-term volatility in earnings.; Using a sample of oil and gas producers for the period 1994-2005, I find no evidence that SFAS 133 is associated with an overall reduction in hedging activities for firms. In addition, I find evidence that is consistent with my hypotheses (albeit insignificantly once I control for fixed effects) that smaller firms, firms with more volatile production, and firms with more transient investors reduce their hedging activities to a greater extent than did larger firms, firms with more stable production, and firms with more long-term investors.; Furthermore, for the subset of firms that disclose information on hedges that qualify and do not qualify for hedge accounting, my results suggest that for hedges that do qualify for hedge accounting, there is a reduction in firms' stock return sensitivity to oil and gas price fluctuations. For hedges that do not qualify for hedge accounting, however, there is an increase in firms' stock return sensitivity to oil and gas price fluctuations. Hedges that do not qualify for hedge accounting may either be hedges for which the firm chose not to apply hedge accounting (i.e., the hedges may have qualified but the firm chose not to apply hedge accounting) or hedges that did not qualify. Although firms maintain that their non-qualifying hedges are used to mitigate risk and are not used for speculative purposes, my evidence suggests that investors treat these non-qualifying hedges as increasing the risk exposure of the firm.