Reporting Derivative Transactions

Paper Summary:

This paper provides an overview of the problem facing regulators and investors in determining the financial integrity of a company today. A definition and discussion of financial derivatives and current reporting requirements for such instruments are provided, followed by an analysis of current and future trends. A summary of the research is provided in the conclusion.

From the Paper:

"Today, corporations are facing a dual pressure to report smooth earnings in an increasingly transparent environment. According to the CEO of a Fortune 500 firm, "[t]he No. 1 job of management is to smooth out earnings" (Barton 2001:1). Consistent with this view, several academic studies have documented that corporate managers make discretionary accounting choices, in part, to reduce earnings volatility. Certainly, earnings management is believed to be so common that the media and regulators are expressing concern about its effects on the quality of reported earnings and the functioning of capital markets in the U.S. and abroad, but to date, the media, academics, and regulators have largely focused on discretionary accounting accruals as the primary means by which managers smooth their firms' earnings. However, corporate managers can also help reduce volatility in earnings by using other tools, such as financial derivatives, that smooth their firms' cash flows (Haberman 2003). The sour taste left in investors' mouths after the collapse of Enron and their ilk, though, have raised a number of questions about whether the current requirements for reporting derivative transactions are useful to investors. To this end, this paper provides an overview of the problem, a definition and discussion of financial derivatives, current reporting requirements for such instruments, followed by an analysis of current and future trends. A summary of the research will be provided in the conclusion."

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