Earnings management with cash flow hedge accounting

Abstract

In this study we examine whether firms use cash flow hedge accounting to manage earnings by deferring derivatives gain/loss amounts to other comprehensive income (designating derivatives as cash flow hedges) or transferring derivatives gain/loss amounts from accumulated other comprehensive income to earnings (de-designating derivatives). We find evidence that firms use cash flow hedge accounting to increase earnings towards a target or take a big bath if reported earnings are below analyst forecasts. Further, we find that earnings management incentives are an important determinant in the decisions to designate derivatives as hedges and de-designate derivatives in cash flow hedges. Finally, our results indicate that the increased transparency of other comprehensive income components after the adoption of ASU 2011-05 significantly reduces earnings management with cash flow hedge accounting but does not eliminate it completely.