Cash Flow Hedges in Other Comprehensive Income

Whether gains and losses from cash flow hedges reported in other comprehensive income (OCI) inform future firm performance -- and whether market participants recognize these signals --remains unclear. Using the setting of production price risk hedging by U.S. oil and gas exploration and production firms and explicitly accounting for the unique features of hedge accounting, we demonstrate that fair value changes of outstanding hedges predict subsequent earnings and operating cash flows. Analysts and investors appear to interpret these signals correctly, distinguishing between the information in OCI related to hedged and unhedged positions of the underlying price risk. Further analysis reveals that both the transaction complexity of derivative portfolios and the complexity of financial reporting affect the information processing abilities of analysts and investors in predictable ways. Overall, our findings indicate that hedge accounting disclosures are value relevant and well understood by capital market participants.