Fair Value Accounting and Managers’ Hedging Decisions

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DOI: 10.1111/j.1475-679X.2012.00468.x Journal of Accounting Research Vol. 51 No. 1 March 2013 Printed in U.S.A.

Fair Value Accounting and Managers’ Hedging Decisions
W E I C H E N , ∗ H U N - T O N G TA N , † A N D E L A I N E Y I N G WA N G ‡ Received 6 September 2011; accepted 6 July 2012


We conduct two experiments with experienced accountants to investigate how fair value accounting affects managers’ real economic decisions. In experiment 1, we find that participants are more likely to make suboptimal decisions (e.g., forgo economically sound hedging opportunities) when both the economic and fair value accounting impact information is presented than when only the economic impact information is presented, or when both the economic and historical cost accounting impact information is presented. This adverse effect of fair value accounting is more likely when the price volatility of the hedged asset is higher, which is a situation where, paradoxically, hedging is more beneficial. We find that the effect is mediated by participants’ relative considerations of economic factors versus accounting factors (e.g., earnings volatility). Experiment 2 shows that enhancing salience of economic information or separately presenting net income not from fair value remeasurements reduces the adverse effect of fair value accounting. Our findings are informative to standard setters in their debate on the efficacy of fair value accounting.

∗ Australian School of Business, University of New South Wales; † Nanyang Business School, Nanyang Technological University; ‡ Isenberg School of Business, University of Massachusetts Amherst. Accepted by Philip Berger. We appreciate helpful comments from an anonymous reviewer, Jun Han, Lisa Koonce, Eng Juan Ng, Terence Ng, Seet-Koh Tan, and workshop participants at Nanyang Technological University. We are grateful to the Institute of Certified Public Accountants, Nanyang Technological University, University of Massachusetts Amherst, and University of New South Wales for financial support. We thank Clarence Goh, Jeffrey Pickerd, Yao Yu, and Bo Zhou for research assistance. 67 Copyright


, University of Chicago on behalf of the Accounting Research Center, 2012



1. Introduction
Standard setters and regulators have implemented fair value accounting across a wide range of financial instruments and other nonfinancial items (SFAS No. 157 and 159). While standard setters and proponents of fair value accounting believe that it provides the most transparent and relevant information for investors’ decision making (Ahmed, Kilic, and Lobo [2011]), fair value accounting has been criticized and resisted by various user groups (Hodder and Hopkins [2012]). Recently, it has also been blamed for causing and exaggerating the 2008 financial crisis (Dontoh et al. [2012]; see Laux and Leuz [2009] for a discussion). A key criticism is that fair value accounting results in excessive volatility when markets become illiquid and market prices are volatile.1 In particular, it has been argued that, because the volatility may not properly reflect the underlying economic fundamentals, it can distort managerial decisions (Plantin, Sapra, and Shin [2008]). Such allegations, along with general criticisms about the role of fair value accounting in the financial crisis, have led to intense lobbying and even moves to eliminate fair value accounting (Gordon [2009]). Despite the importance of this issue, there has been little empirical evidence on whether managers’ real economic decisions are actually adversely affected by fair value accounting.2 Prior studies have found that managers opportunistically use fair value estimates to manage earnings (Dietrich, Harris, and Muller [2001]) and achieve higher compensation benefits (Dechow, Myers, and Shakespeare [2010]), but none of them has documented a distortion of real decisions in terms of sacrificing of economic value caused by fair...
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