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The effects of corporate governance and accounting rule changes on derivatives usage

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Abstract

The ongoing growth in use of financial instruments together with the accompanying disclosing requirements debate has motivated this study to examine the role of internal corporate governance and accounting rule changes in firms’ derivatives using derisions. The empirical results reveal that firms with better internal corporate governance have higher demand on hedging-purpose derivatives usage in Taiwan. Moreover, the magnitude of hedging-purpose derivatives usage significantly decreases following the enforcement of SFAS No. 34. It is also found that firms with better internal corporate governance are moderate negatively associated with the non-hedging-purpose derivatives usage and the effect of SFAS No. 34 is statistically insignificant in this testing. This study implements several diagnostic checks and demonstrates the results are robust to various specifications.

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Notes

  1. According to the Company Act, the supervisors shall supervise the execution of business operations of the company, and may investigate the business and financial conditions of the company, examine the accounting books and documents, and request the board of directors or managerial personnel to make reports thereon at any time or from time to time. (Article No. 218) Further, supervisors shall audit the various statements and records prepared for submission to the shareholders’ meeting by the board of directors, and shall make a report of their findings and opinions at the meeting of shareholders. In performing their functional duties under the preceding Paragraph, the supervisors may appoint a certified public accountant to conduct the auditing in their behalf. (Article No. 219)

  2. Although a derivative’s notional amount is usually much larger than its fair value, it is nonetheless a viable measure of hedging because it represents (1) the amount exposed to changes in the value of the underlying, and (2) the basis for calculating the amounts exchanged by the parties to the derivative (e.g., Guay 1999; Allayannis and Ofek 2001; Barton 2001).

  3. The maximum VIF value is 1.437 for the STD variable in Eq. (1) and 5.176 for the interactive variable (CGCI\(\times \)D_34) in Eq. (2) using the entire sample.

  4. This study had used the fixed-effect unbalanced-panel data regression model to construct the empirical test. This procedure allows us to control for clustering at the firm level and year effect and provides confirmatory evidence to support the hypotheses. The untabulated results are consistent with the initial findings.

  5. We use principal component analysis to form factors that capture different dimensions of corporate governance. In this procedure, we find two factors with an eigenvalue greater than unity, i.e., 2.609 and 1.023 respectively. These factors capture 63.534 and 17.051 %, respectively, of the total variance of the original data. This study thus retains the first factor and extracts its factor scores that represent the initial CGCI variable.

  6. Firm’s decision of derivatives usage may advance the date of formal enforcement and lead to inadequate measuring the cutoff point of SFAS No. 34 enforcement. This study thus uses year 2005 as an alternative cutoff point of SFAS No. 34 and reruns the equations. Additionally, we incorporate the 83 observations which both take hedging and non-hedging derivatives into examination. The additional diagnoses do not qualitatively change the primary results.

  7. The authors wish to express their thanks to the referee for the constructive suggestion that this study could broaden the scope to examine the stock price reactions associated with the new disclosure requirements that negatively affected hedgers by reducing their derivatives use to suboptimal levels.

  8. Ohlson (1995) begins with the stock valuation of dividend discounting, basic assumptions of a clean surplus relation and the dynamic linear information model, to construct an accounting-based valuation model by considering the market value, current earnings, equity book value, and other value-relevant information. It appears that there is consensus among accounting researchers that one of the desirable properties of the Ohlson model is its formal linkage between valuation and accounting numbers (Lundholm 1995; Dechow et al. 1998; and among others). The Coopers and Lybrand Accounting Advisory Committee (1997) advocates that empirical research evaluating financial reporting standards promulgated by standard setting bodies is best conducted through the Ohlson framework.

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Acknowledgments

The authors wish to express their heartfelt thanks to the anonymous reviewer for his valuable comments and suggestions. The first author thanks to the financial support generously provided by National Science Council in Taiwan. An earlier draft was presented at The Technology Innovation and Industrial Management, Lublin University, Lublin, Poland, May 22–25, 2012. The authors are indebted to the participants at the meeting for their valuable suggestions.

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Authors and Affiliations

  1. Department of Accounting, National Yunlin University of Science and Technology, No.123 University Road, Section 3, Douliou, Yunlin, 64002, Taiwan, ROC

    Ching-Lung Chen

  2. Department of Accounting, Fu Jen Catholic University, No. 510 Zhungzheng Road, Xinzhuang Dist, New Taipei City, 24205, Taiwan, ROC

    Hung-Shu Fan

  3. PwC CPAs, 25F, 333 Keelung Road, Section 1, Taipei, 11012, Taiwan, ROC

    Ya-Ming Yang

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  1. Ching-Lung Chen
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Correspondence to Hung-Shu Fan.

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Chen, CL., Fan, HS. & Yang, YM. The effects of corporate governance and accounting rule changes on derivatives usage. Rev Deriv Res 17, 323–353 (2014). https://doi.org/10.1007/s11147-014-9100-5

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