The impact of derivatives on firm risk: An empirical examination of new derivative users

The appropriateness of financial reporting rules for derivative securities depends on corporations' reasons for using the instruments. Empirically, little is documented about how the instruments affect firms' risk exposures, This study examines derivatives' roles in firms initiating derivatives use. The results are consistent with firms using derivatives to hedge, and not to increase, entity risk. Firm risk (measured several ways) declines following derivatives use. Realized risk reductions and decisions to initiate derivatives programs vary across firms with the expected benefits from hedging. The findings emphasize the importance of hedge-accounting rules that incorporate the impact of derivatives and hedged items simultaneously. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classification: M41; G3.