Assessing the Information Content of Mark-to-Market Accounting with Mixed Attributes: The Case of Cash Flow Hedges

<heading id="h1" level="1" implicit="yes" format="display">ABSTRACT</heading>We examine how outsiders rationally interpret a reported loss on derivatives when the application of mark-to-market accounting to cash flow hedges creates a mixed attribute problem. We find that because of the mixed attribute problem, the information content of mark-to-market accounting is related to the information content of historical cost accounting in a very specific way. This relationship allows us to identify the circumstances under which mark-to-market accounting facilitates and when it detracts from the objective of providing an early warning of potential financial distress. We show that the reporting of an impending derivative loss by a distressed firm can actually lead outsiders to infer that the firm is in a better financial position than what they would have inferred under the silence associated with historical cost accounting. Without the mixed attribute problem, mark-to-market accounting would always yield more accurate assessments of the firm's financial position. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2007.