Empirical Analysis of Effects of SFAS No. 133 on Derivative Use and Earnings Smoothing

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32 Pages Posted: 9 Nov 2004

See all articles by Wei Li

Wei Li

Washington State University - School of Accounting, Information Systems, and Business Law

William W. Stammerjohan

Louisiana Tech University - College of Business

Date Written: November, 2004

Abstract

Managers use derivatives to reduce cash flow volatility and achieve earnings smoothing. In 1998, FASB issued SFAS No. 133, under which firms are no longer allowed to simultaneously record all offsetting gains and losses on the items being hedged. Thus, critics argued that this treatment could potentially induce volatility in earnings. The critics also argued that SFAS No.133 would deter the use of derivatives. Consequently, cash flows were expected to become more volatile, which would also lead to increased volatility in earnings. Based on a sample of Fortune 500 firms, the current study documents that: (1) derivative usage did not significantly decline following the implementation of SFAS No. 133, and (2) derivative users' cash flow volatility did not increase. Although derivative users' earnings volatility did increase during the period 1997 to 2002, the evidence suggests that this increase may have been caused by factors other than SFAS No. 133.

Keywords: derivatives, cash flow volatility, earnings smoothing, SFAS No. 133

Suggested Citation

Li, Wei and Stammerjohan, William W., Empirical Analysis of Effects of SFAS No. 133 on Derivative Use and Earnings Smoothing (November, 2004). Available at SSRN: https://ssrn.com/abstract=616901 or http://dx.doi.org/10.2139/ssrn.616901

Wei Li (Contact Author)

Washington State University - School of Accounting, Information Systems, and Business Law ( email )

College of Business & Economics
Pullman, WA 99164-4729
United States

William W. Stammerjohan

Louisiana Tech University - College of Business ( email )

Railload and College Ave.
Ruston, LA 71272
United States