Derivatives Use and its Consequences for Management Earnings Forecasts

Using hand collected data on firms’ derivatives use from 1997 to 2019, we provide the first empirical evidence on how firms’ derivatives use impacts voluntary disclosure, and offer four main findings. First, we find a positive association between derivatives use and the frequency of management earnings forecasts, suggesting that when firms use derivatives they also increase voluntary disclosure. Second, using path analysis we find that the channel linking the use of derivatives to increased forecast frequency is that derivatives reduce earnings volatility and therefore make it easier to forecast earnings. Third, we find that CEOs with more pronounced career concerns increase forecast frequency only when derivatives make earnings more predictable, and find no evidence that investor demand drives the decision to provide a forecast. These results suggest that the primary mechanism for the association between derivatives use and forecast frequency is a reduction in the manager’s costs of providing the forecasts. Finally, we find that the majority of these derivatives-induced forecasts are uninformative to capital market participants, especially after FAS 161 provided the necessary underlying data to understand firms’ derivatives use. Overall, we provide the first empirical evidence that firms that use derivatives issue more management forecasts, but also find that these incremental forecasts are largely uninformative to outsiders and instead appear to be driven by the career concerns of management.