Do Mandatory Hedge Disclosures Discourage or Encourage Excessive Speculation?

Author: Sapra, Haresh

Source: Journal of Accounting Research, Volume 40, Number 3, June 2002 , pp. 933-964(32)

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Abstract:

In order to shed some light on the desirability of hedge disclosures, I investigate the consequences of hedge disclosures on a firm's risk management strategy. Several major results emerge from this analysis. First, greater transparency about a firm's derivative activities is not necessarily a panacea for imprudent risk management strategies. I show that such transparency actually induces the firm to take excessive speculative positions in the derivative market. Second, I show that the firm may choose a prudent risk management strategy in the absence of hedge disclosures. However, the selection of a prudent risk management comes at a cost. The firm's production policy is distorted in the absence of hedge disclosures.

These findings suggest that regulators must carefully investigate the trade-offs between production distortions and risk management distortions in evaluating the desirability of mandatory hedge disclosures for all firms.

Document Type: Research article

DOI: http://dx.doi.org/10.1111/1475-679X.00077

Affiliations: 1: The University of Chicago, Graduate School of Business

Publication date: 2002-06-01