Hedging, Hedge Accounting, and Stock Price Crash Risk: Evidence from China

Abstract

Synopsis The research problem This study examines the association between hedge-based derivatives usage and stock price crash risk, as well as the moderating effect of International Financial Reporting Standard 9 — Financial Instruments (IFRS 9) hedge accounting requirements on the association between derivatives usage and stock price crash risk in China. Motivation A growing number of companies worldwide are using financial derivatives to hedge risks; however, evidence is mixed on whether hedge-based derivatives usage increases or decreases firm transparency. While prior studies have demonstrated that financial reporting complexity can affect the informational effect of derivatives, evidence is limited on whether and how the recent changes in hedge accounting requirements in IFRS 9 affect the capital market outcomes of derivatives. Using data from China, one of the largest emerging markets, we tested the informational effects of hedge-based derivatives usage and IFRS 9 requirements to provide incremental evidence on the market outcomes of firm use of financial derivatives. The findings have implications for international investors and facilitate the International Accounting Standards Board’s (IASB) postimplementation review of the IFRS 9 hedge accounting requirements. The test hypotheses Our first hypothesis is that no association exists between hedging and stock price crash risk in China. Our second hypothesis is that the implementation of IFRS 9 requirements does not influence the association between hedging and stock price crash risk in China. Target population This study is of interest to accounting and finance researchers, firm managers, accounting practitioners, international accounting standard setters, regulatory authorities, and investors. Adopted methodology Ordinary least squares (OLS) regressions, difference-in-differences (DiD) research design, propensity score matching (PSM), and entropy balancing (EB) are used in this research. Analyses We manually collected derivatives-related information (including purposes of derivatives usage, measurement basis of the derivatives, and hedge accounting treatment) from the annual reports of firms listed on the mainboard of the Shanghai and Shenzhen stock exchanges from 2016 to 2021. We adopted OLS and a DiD research design to test our hypotheses, and used the PSM and EB methods to address endogeneity concerns. Findings We find a positive association between hedging and stock price crash risk among the listed Chinese companies. Furthermore, after the implementation of IFRS 9, stock price crash risk decreases more among the hedgers than among firms without financial derivatives. Our channel tests show that IFRS 9 increases the quality of hedge accounting information, thus reducing stock price crash risk. The cross-sectional tests further support the capability of IFRS 9 to reduce noise contained in hedge accounting information, therefore improving firm-level transparency.