1 Discretionary accruals, hedging, and firm value

We examine the effect of the interaction between discretionary accruals and hedging with derivatives on firm value, as captured by the log of Tobin’s Q. Several key findings emerge. First, a proportional increase of accrual management relative to hedging for earnings smoothing reduces firm value. Second, the relative use of discretionary accruals to hedging declines with the percentage of outside directors, audit committee meeting frequency, and the percentage of outsiders sitting on the audit committee. These results suggest that boards and audit committees structured to be more independent of the management, and audit committees with more frequent meetings are more effective in monitoring the choice of the earnings smoothing devices. Third, the intensity of discretionary accruals is negatively related to firm value, consistent with the premise that managers use accounting methods opportunistically to maximize their utility at the expense of other contracting parties. Finally, firm value increases with the level of derivatives use, supporting extant theories tha