Characteristics of firms that enter into interest rate swaps and valuation of deferred taxes under SFAS No. 109

This paper analyzes the differential use of interest rate swaps by non-financial companies in the S&P 500, based on disclosures under recent accounting standards. The paper tests various theories propounded for the use of swaps, with particular emphasis on hedging theories. Firms that swap are larger and have higher debt to equity ratio. Firms whose investments are sensitive to internal cash flows enter into swaps more than other finns. Firms that enter into swaps have higher sensitivity to interest rates and have lesser long term fixed debt. No support is found for the quality spread differentials explanation and poor explanatory power is obtained in distinguishing between firms that enter into fixed rate swaps and variable rate swaps. Lastly, the paper discusses the implications for evolving accounting standards. Both the correlation of firm income to changes in interest rates and how the type of swap entered into affects that correlation are important as required disclosures.