Hedge accounting and firms’ future investment spending

Finance theory suggests that effective hedging reduces cash flow volatility, enabling firms to invest in profitable projects they might otherwise avoid. We argue that this association holds only for derivatives designated for hedge accounting, which requires the fulfillment of strict effectiveness criteria. Our evidence shows that only designated derivatives are positively associated with future investments, indicating that hedge accounting serves as a helpful signaling device for stakeholders regarding the success of firms’ hedging programs. However, firms using complex hedging strategies seem unable to designate some of their successful derivatives due to the often-criticized strict criteria for hedge accounting.