Derivatives use and disclosure in the Australian extractives industry

Accounting and Finance 53 (2013) 5583
Derivatives use and nancial instrument disclosure in the extractives industry

Jacqueline Birt, Michaela Rankin, Chen L. Song
Department of Accounting and Finance, Monash University, Cauleld, VIC, Australia
Abstract This article documents the use and disclosure of derivatives in the Australian extractives industry. We nd that derivatives are used by 23 per cent of our sample, with mitigation of commodity risk and foreign exchange risk being the most common purposes for which derivatives are used. The most common types of derivatives used in the sector for hedging purposes are forward rate agreements and options. Results indicate that derivative use is positively associated with nancial risk and rm size. We also examine the relation between rm characteristics and the extent of nancial instrument disclosure, using a disclosure index based on the additional requirements in IFRS 7 Financial Instruments: Disclosures. Empirical results reveal that large rms with higher leverage, which use derivatives, and are audited by a Big 4 auditor provide more extensive disclosure of nancial instruments. Key words: Derivatives; Financial instruments; Hedging; Extractive industry; IFRS 7 JEL classication: G32, M41, M48 doi: 10.1111/ac.12001
1. Introduction Recent large losses from derivatives (Simmons and Keehner, 2008; West, 2008; Izumi, 2009) highlight concerns about the use and adequate disclosure of nancial instruments, and particularly derivatives by Australian rms (ASIC, 2008). Derivatives can be used for both trading and hedging purposes. Derivatives for trading purposes are used to acquire risk whereby individuals or rms speculate on the value of an underlying asset. Firms also use derivatives to hedge their own exposure to risks resulting from interest rate, commodity price and foreign exchange rate uctuations, and more recently weather risk.
Received 30 April 2011; accepted 23 August 2011 by Robert Fa (Editor). 2012 The Authors Accounting and Finance 2012 AFAANZ
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J. Birt et al./Accounting and Finance 53 (2013) 5583
Risks associated with the use and trading of derivatives is a burgeoning issue. In 2010, the total notional amount of outstanding over-the-counter (OTC) market derivatives stood at $601 trillion US (Bank for International Settlements, 2011). While, historically signicant losses have been associated with derivative nancial instrument trading,1 derivative use for hedging purposes has also contributed to corporate collapse. A contributing factor to the collapse of both Sons of Gwalia Ltd and Croesus Mining Ltd was the nondisclosure associated with the use of gold hedge books and hedging activities. Cases such as these, and other high prole examples such as Enron, have led to an increased demand from investors to have transparent reporting of nancial risk management practices (Hassan et al., 2006a). Hodder et al. (2001) argue that inadequate quantitative disclosure of risks from derivative nancial instruments may lead investors to assign inappropriate risk levels in their investment decisions. Thus, rms are likely to be mispriced by the market (Hodder et al., 2001). The risks associated with the use of derivatives in the Australian extractives industry are of particular importance to the Australian corporate environment. This industry makes a signicant contribution to the Australian economy, generating 5 per cent in real term GDP in 2008 (Business Monitor International Ltd, 2009). Specically, coal and iron ore are the top two exports for the Australian extractives industry, and Australia is the worlds largest and third largest exporter of coal and iron ore, respectively (Business Monitor International, 2011). In the last decade, the growth in these two exports has been nearly sixfold from $12 billion in 1999 to $69.4 billion in 2009 (DFAT, 2011). Indeed, the sector is important globally. It is estimated that over 20 per cent of the European Unions gross domestic product is dependent upon the extractives sector (Brodkom, 2001), and many extractives companies are richer and more powerful than the countries that regulate them (Leaver and Cavanaugh, 2010). Eight of the worlds top 20 companies are from the extractives sector Royal Dutch Shell, ExxonMobil, BP, Sinopec, Chinese National Petroleum, Chevron, Total and ConocoPhillips (Fortune Magazine, 2010). The sector is subject to potentially high exploration and production risks (Hassan et al., 2006b; Taylor et al., 2010), which lead to rms employing derivative nancial instruments to mitigate both existing and potential risks. In addition, the volatility resulting from the requirement to measure commodity prices and foreign currency receivables and payables at fair value increases the nancial risk
In December 1993, Metallgescellschaft AG revealed that its Energy Group was responsible for losses of approximately $1.5 billion due mainly to cash-ow problems resulting from large oil forward contracts (Digenan et al., 2004). Barings Bank was declared bankrupt (lost $1.4 billion) after trading options on the Japanese stock index (Stock Market Crash, 2008). These constitute just two examples where losses from derivatives trading have contributed to corporate collapse. 2012 The Authors Accounting and Finance 2012 AFAANZ
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to extractives rms.2 Extractive rms commonly utilise derivatives to hedge commodity prices, foreign exchange risk and interest rate risk (Chalmers and Godfrey, 2004; Taylor et al., 2008). As previously indicated, corporate collapses do not result purely from speculation or trading of derivatives. Financial risks associated with hedge arrangements contributed to the collapse of several extractives companies, including both Sons of Gwalia Ltd and Croesus Mining Ltd (Taylor et al., 2010). Taylor et al. (2010) contend that, leading up to these corporate failures, information about risks from hedge restructuring, credit limits and cash ows may not have been fully disclosed. In an attempt to improve disclosure of the risk associated with nancial instruments, and in particular derivatives use, the International Accounting Standards Board (IASB) issued IFRS 7 Financial Instruments: Disclosures (IASB, 2005) for adoption on 1 January 2007 (AASB, 2005). The application of IFRS 7 requires substantially greater disclosure than its precursor IAS 32 Financial Instruments: Disclosure and Presentation and has introduced signicant challenges to many entities (Grant Thornton, 2008). Most of these challenges arise from the increased focus on both quantitative and qualitative disclosure of nancial instruments and the large amount of disclosure, required to be presented from a management perspective, of how they monitor and control the risks arising from employing nancial instruments (Grant Thornton, 2008). The majority of the expanded disclosure requirements relate to the use of more complex nancial instruments such as derivatives. In this article, we seek to expand our understanding of derivative nancial instrument use and disclosure in the Australian extractives industry. We initially document the extent to which extractive rms use derivatives to mitigate the nancial risk associated with their nancing and operations and examine the relationship between derivative use and a range of rm characteristics such as leverage, size and rm performance. In addition, we investigate the extent of detail sample rms disclose about all types of nancial instruments including derivatives. In doing so, we develop a disclosure index based on the additional requirements in IFRS 7, beyond those that were mandatory under the previous IAS 132/AASB 132 requirements. Further, we explore the relation between the extent of nancial instrument disclosure and a range of rm characteristics, including derivative use. Our research makes a number of contributions to the extant literature. First, little is known about the use of derivatives by rms specically in the extractives sector, in the current market. All publicly listed entities use some form of nancial instruments;3 however, Berkman et al. (2002) noted the substantial
While fair value issues aect the measurement of nancial instruments and the nancial risk faced by rms in the extractives sector, nancial instrument measurement is beyond the scope of the current study and is acknowledged as an area for future research. Receivables, payables and loans are all classied as nancial instruments (AASB 132, para 11 AASB, 2004). 2012 The Authors Accounting and Finance 2012 AFAANZ
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proportion of mining rms that specically utilised derivatives.4 Similarly, Heaney and Winata (2005), in their examination of derivatives used by top 500 Australian rms in 1999, found that approximately 82 per cent of extractive rms in their sample used derivatives.5 Second, we contribute to our understanding of nancial instrument disclosure practices. While prior research has explored general disclosure of nancial instruments or derivatives in the extractives industry, this work has been restricted to a voluntary setting (Chalmers and Godfrey, 2004) or a period subject to lesser disclosure requirements than the current study.6 Studies such as those conducted by Nguyen and Fa (2002, 2003) examined determinants of derivative use by the largest Australian listed rms in 1999 and 2000. Our study contributes to the literature by documenting the range of derivatives currently in use by the Australian extractive sector and the extent of disclosure about how nancial instruments are used to mitigate the nancial risk associated with ongoing operations. We go beyond the largest rms examined in prior research and draw our sample from across the whole sector, thus contributing to our knowledge about derivative use and disclosure activities across all areas of the extractives industry. Third, we provide further insights into IFRS implementation from an Australian perspective in an industry which is of great importance to the Australian corporate environment. Recall that Australias largest two exports are coal and iron ore, contributing $69.4 billion in 2009. Finally, our results add to prior research which investigates the association between the extent of nancial instrument disclosure and rm characteristics in a setting subject to greater mandatory reporting requirements that prior research. Lopes and Rodrigues (2007) and Hassan et al. (2008) examine determinants of nancial instrument disclosure in accordance with the less comprehensive IAS 32 in Portugal and Malaysia, respectively. In Australia, Wei and Taylor (2009) restrict their study to the extent of fair value disclosures only, while Taylor et al. (2010) document disclosure of nancial risk, both again, in a setting prior to the application of IFRS 7/AASB 7. These new accounting regulations require more extensive disclosure of quantitative information, market risk, credit risk and liquidity risk areas that particularly impact on rms that use derivatives and on extractives rms due to the nature of their activities. Consequently, this article extends prior research to assess the rm
Berkman et al. (2002) found 61.5 per cent of mining rms in their sample used at least one form of derivative nancial instrument, when compared to only 52.8 per cent of industrial sample rms. This study was based on Australian rms in 1995. Eighty-three per cent of gold explorer/producer rms and 81.8 per cent of minerals/bass metals producers disclosed derivatives use.
6 While Chalmers and Godfrey (2000) and Hassan et al. (2006b) focus on extractive rms disclosure practices in accordance with AASB 1033 Presentation and Disclosure of Financial Instruments, Taylor et al. (2008) examine Australian resource rms nancial instrument disclosures pursuant to AASB 132 Financial Instruments: Disclosure and Presentation.
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characteristics that determine nancial instrument disclosure level under the new IFRS 7/AASB 7 reporting regime for both derivative users and non-users. Our results reveal that derivatives are used by 79 rms (23 per cent) from our sample. Commodity risk and foreign exchange risk mitigation are the most common purposes for which derivatives are used. Forward rate agreements and options are used most frequently in hedging nancial risk. Empirical analysis indicates that, consistent with prior research (see, e.g. Berkman et al., 2002; Nguyen and Fa, 2002), derivative use is associated with rm size and nancial leverage. Large rms with high leverage, which are audited by a Big 4 auditor and use derivatives are likely to provide more extensive disclosure relating to nancial instruments. Results also provide feedback to standard setters indicating the extent to which Australian rms are adequately disclosing nancial instruments in accordance with IFRS 7. In turn, it will inform future amendments to these accounting standards.7 We commence the article with a brief discussion of the regulatory background to IFRS 7, including the risks associated with, and incentives to use, derivatives. An overview of prior research that has examined the use of derivatives and disclosure of nancial instruments follows in section 3. The research method used to assess the determinants of both derivative use and nancial instrument disclosure is documented in section 4, in which we also examine the use of derivative nancial instruments by sample rms. The penultimate section presents results of tests that examine the relation between both derivative use and nancial instrument disclosure and a range of rm characteristics. We conclude in section 6 by reiterating our ndings and outlining limitations and avenues for future research. 2. Regulatory background 2.1. Regulations governing disclosure of nancial instruments Australia issued its rst mandatory accounting standard on nancial instrument disclosures AASB 1033 Presentation and Disclosure of Financial Instruments in December 1996. Following implementation of the Financial
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In response to the 20072008 credit crisis and following recommendations of the Financial Stability Forum, the IASB published an Exposure Draft 08FR-051 (ED) Improving Disclosures about Financial Instruments (proposed amendments to IFRS 7) in October 2008 (IASB, 2008). The ED sought to improve disclosure requirements relating to o-balance sheet nancial securities and strengthen the standard to achieve better disclosures about valuations, methodologies and uncertainties associated with valuations, with a particular focus on fair value measurement and liquidity risk (Deloitte and Touche, 2009). The changes, which were incorporated into IFRS 7 eective 1 January 2009, were welcomed by academics and practitioners; however, some issues regarding the complexity of the requirements (Group of 100, 2008) and reclassication of nancial assets (European Financial Reporting Advisory Group, 2008) were noted. 2012 The Authors Accounting and Finance 2012 AFAANZ
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Reporting Council (FRC) decision to adopt IFRS, applicable to reporting periods beginning on or after 1 January 2005, AASB 132 the Australian equivalent of IAS 32 Financial Instruments: Disclosure and Presentation replaced AASB 1033. IFRS 7 Financial Instruments: Disclosures was issued by the IASB to replace part of IAS 32 in order to improve disclosure quality (ICAA, 2008).8 Consistent with the old IAS 132, the objective of IFRS 7/AASB 7 is to require entities to provide disclosures in their nancial statements that enable users to evaluate (i) the signicance of nancial instruments for the entitys nancial position and performance and (ii) the nature and extent of risks arising from nancial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. (AASB 7 para 1, AASB, 2005). However IFRS 7/AASB 7 introduces additional, more extensive requirements that are designed to provide an overview of the entitys use of nancial instruments and the exposure to risks they create (para 31). The additional requirements in IFRS 7 provide greater transparency regarding risks associated with amount, timing and uncertainty of an entitys future cash ows, which allows nancial report users to make more informed judgements about risk and return (IASB, 2004). Furthermore, it requires broad disclosure of risks relating to nancial securities, in addition to interest rate risk (which was required by IAS 132) including liquidity risk and detailed disclosure of credit risk. 2.2. Risks and incentives to use derivative nancial instruments As previously discussed, derivatives are used by rms for both trading and hedging purposes. Derivative use does not only allow companies to hedge against a variety of risks, but can also magnify those risks (Geczy et al., 1997; Hassan et al., 2006a; Al-Shboul and Alison, 2009). Geczy et al. (1997) note that US companies use of derivatives results in reduced levels of risk. Innovative and complex nancial instruments are continuously being introduced by nancial intermediaries to help rms manage their risk exposures (Hassan et al., 2006a). Accompanying the development of nancial instruments, there have been concerns that using increasingly complex instruments could undermine the stability of nancial markets (International Monetary Fund, 2007). Barnes (2002) indicates that maximisation of rm value is not the sole motivation for managers to hedge they also seek to maximise their own interests.
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During a similar time frame, FASB issued several statements to amend nancial instruments regulations: (i) Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140 in March 2006 and (ii) The Fair Value Option for Financial Assets and Financial Liabilities including an amendment to FASB Statement No. 115 in February 2007. The recent FASB pronouncement relates to Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140 in June 2009. 2012 The Authors Accounting and Finance 2012 AFAANZ
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Managers with more stock options are less likely to hedge against stock price movement, whereas managers who are remunerated with a larger proportion of shares are active in managing stock price risk (Tufano, 1996). As previously stated, rms in the extractives industry are subject to high levels of risks from uctuations in commodity prices, interest rates and foreign exchange rates (Chalmers and Godfrey, 2004; Taylor et al., 2008) and the resulting volatility associated with using fair value to measure nancial assets and liabilities. Consequently, they have incentives to utilise derivatives to mitigate these risks. 3. Prior research Limited research has examined derivative use in Australia, with this work conducted prior to 2000 (see e.g. Berkman et al., 2002; Nguyen and Fa, 2002, 2003; Heaney and Winata, 2005). Prior literature which has examined the extent of nancial instrument disclosure was set either in a voluntary disclosure regime (Chalmers and Godfrey, 2004) or in a setting with less-extensive disclosure requirements (see e.g. Chalmers and Godfrey, 2000; Lopes and Rodrigues, 2007; Taylor et al., 2008, 2010). Nguyen and Fa (2002) investigated the determinants of derivative use by large Australian rms in 1999 and 2000. They found that 74.2 per cent of their sample used derivatives and usage was associated with rm characteristics of leverage (proxying for nancial distress), rm size (proxying for nancial distress and set-up costs) and liquidity (proxying for nancial constraints). Nguyen and Fa (2003) extended their previous analysis and focused on foreign currency and interest rate derivatives. They found that the use of foreign currency derivatives were associated with leverage and rm size. Interest rate derivative use was associated with leverage, liquidity and payment of dividends. Heaney and Winata (2005) found derivative use prevalent in the largest Australian rms in 1999. On average, they observed that 65 per cent of rms disclosed derivative use. As previously noted, this was higher for extractives rms (approximately 82 per cent). The authors found derivative use to be associated with economies of scale, nancial distress, agency costs, optimal investment, management compensation and foreign business exposure. Berkman et al. (2002) showed that rm size and leverage (as a proxy for the probability of nancial distress) explain derivative use in both industrial and mining rms. A survey of managerial views and attitudes on derivative use by Benson and Oliver (2004) revealed that managers focused on the reduction of risk and the volatility of cash ows and earnings in using derivatives. Reducing bankruptcy costs and taxation, which have been hypothesised in prior research, were not important determinants. Chalmers and Godfrey (2000) investigated the 1998 disclosure of derivative accounting policy and measurement practices pursuant to the introduction of AASB 1033 Presentation and Disclosure of Financial Instruments. They found the quality of disclosure to be low, with a lack of clarity around derivatives use and
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disclosure (derivative use was sometimes implied rather than explicit). Across a sample of 150 rms drawn from the top 500, the authors found that all rms that used derivatives did so for hedging purposes, with few rms engaging in speculative trading. Currency and interest rate derivatives were the most common. As stated earlier, prior studies that examined nancial instrument disclosure in the extractives industry (see e.g. Chalmers and Godfrey, 2000; Hassan et al., 2006b; Taylor et al., 2008, 2010) did so in a regime subject to dierent mandatory reporting requirements (either AASB 1033 or IAS 32/AASB 132) or examined a subset of nancial instrument disclosure issues such as fair value measurement (Wei and Taylor, 2009) or nancial risk management (Taylor et al., 2010). An implication of Modigliani and Millers (1958) perfect market world is that the value of a rm is independent of its hedging policy as individual security holders can organise their own hedging strategies to rebalance their portfolios and leave wealth unchanged. However, research has provided an alternative view that hedging can be value-enhancing because investors may not be in the position to undertake the same hedging techniques and strategies themselves (Myers, 1977; Smith and Stulz, 1985). These models have produced a range of testable hypotheses relating to derivative use and rm characteristics (Berkman et al., 2002), a number of which will be examined in this study. 3.1. Derivative use, disclosure and rm performance In the current business environment, nancial securities are closely linked to rm performance (Othman and Ameer, 2009), with many companies undertaking extensive derivative trading (Batten and Hettihewa, 2007), either for the purposes of hedging risk or for speculation. Derivatives have been found to reduce the probability of a company entering nancial distress (Smith and Stulz, 1985; Nguyen and Fa, 2002; Heaney and Winata, 2005). Derivative use is valueenhancing as it alleviates costs (Froot et al., 1993; Nance et al., 1993). Empirical evidence of the relation between performance and disclosure is mixed however. When rm performance is positively related to the use of nancial instruments, Hassan et al. (2006a) nd that managers are likely to disclose detailed information to provide relevant data about their current operations, or to justify the further employment of nancial instruments. Wallace et al. (1994) present a contradicting argument however, proposing that a rm which is not performing well will increase disclosure in order to explain its weak performance. Lang and Lundholm (1993) note disclosure may be related to performance variability and demonstrate that disclosure may increase, remain constant or decrease in line with rm performance (Lang and Lundholm, 1993; Wallace et al., 1994). While Wei and Taylor (2009) and Hassan et al. (2006b) nd that high-performing rms are likely to provide greater levels of information; Wallace et al. (1994) and Hassan et al. (2008) nd no relation. Therefore, the expected direction of the association is an empirical question.
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3.2. Derivative use, disclosure and nancial risk Utilising derivative nancial instruments exposes rms to nancial and economic risks which may arise from changes in the general economic environment or changes in business conditions of counterparties (Hassan et al., 2006a). Risk exposures could also cause earnings volatility which negatively inuences investors perceptions of a rms performance (Hassan et al., 2006a). Therefore, managers have incentives to use nancial instruments to minimise or oset these risks (Hassan et al., 2006a). Nance et al. (1993) indicate that derivative hedging can increase a rms value and consequently maximise shareholder value. Prior studies argue agency costs are higher for rms that engage in more external nancing, because of the potential wealth transfers amongst management, shareholders and debt holders (Ertugrul and Hegde, 2008; Guay, 2008; Brockman and Unlu, 2009; Florackis and Ozkan, 2009). The level of nancial risk experienced is also likely to relate to rms willingness to disclose (Chow and Wong-Boren, 1987; Lang and Lundholm, 1993). According to Lang and Lundholm (1993), the level of disclosure is likely to be correlated with nancial risk if nancial risk is a proxy for information asymmetry between managers and outside parties. As the variability of prior performance is an indicator of unpredictability of future operations, in the presence of adverse selection problems, rms with great variation in prior performance tend to have more severe information asymmetry (Lang and Lundholm, 1993). A highly levered rm is likely to provide more detailed disclosure to assure debt holders that management is not acting opportunistically (Chow and Wong-Boren, 1987; Hossain et al., 1995; Inchausti, 1997; Nguyen and Fa, 2002; Ali et al., 2004). Additionally, the cost of equity and debt can be reduced by an increase in the level of disclosure (Botosan, 1997; Sengupta, 1998). Jorgensen and Kirschenheiter (2003) examine managers discretionary disclosure of risk information and show that ceteris paribus, in a voluntary disclosure regime, rms that disclose risk information have a higher share price than those that do not, leading to the conclusion that it is more benecial to disclose risk information. Consistent with ndings by Berkman et al. (2002), Heaney and Winata (2005) and Nguyen and Fa (2002), we propose that rms with higher levels of nancial risk, measured by leverage, are more likely to utilise derivatives. In addition, we propose that rms that incur higher levels of nancial risk have greater incentives to disclose information to indicate how nancial instruments are utilised to mitigate risk exposure. 3.3. Derivative use, disclosure and committee governance As previously indicated, the use of complex nancial instruments presents additional challenges to rms risk management. Audit committees and risk management committees are increasingly being used to manage operational,
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economic and nancial risks (Fraser and Henry, 2007). Fraser and Henry (2007) document the successful use of audit committees in improving risk management practices. The authors found that where audit committees are involved in risk management, they rely on the internal audit function to assure risk management procedures and in turn report their ndings to the board. Companies are increasingly using risk management committees to deal with the complex issues surrounding all aspects of rm risk (Fraser and Henry, 2007). Risk management committees generally have a broader range of expertise across the range of issues aecting risk management of the organisation and may include executives with legal, health and safety, operations as well as nance expertise (Fraser and Henry, 2007). The authors note that a risk management committees with this breadth of expertise is perceived to be a better forum than the audit committee to monitor the quality of risk management. It is anticipated that boards which institute additional risk management processes through either the audit or risk management committee are likely to have a greater understanding of the ability of derivatives to mitigate various risks and are also in a better position to disclose more detailed information about how they are managing these risks. 3.4. Derivative use, disclosure and audit quality The quality of the external audit process is also considered to be a means of reducing agency costs between principals and agents (Jensen and Meckling, 1976; Watts and Zimmerman, 1983). Firms with substantial agency costs and the intention to reduce them are more likely to be audited by a Big 4 auditor. Big 4 audit rms have the expertise, including knowledge about appropriate derivatives use and disclosure, to enable the supply of a higher-quality audit. Therefore, rms that have Big 4 auditors are likely to have a higher level of disclosure and signal the quality of a rms disclosure to the market (Craswell et al., 1995; Chalmers and Godfrey, 2004). 3.5. Derivative use, disclosure and rm size Larger companies are more likely to utilise derivatives than smaller companies (Berkman et al., 2002; Nguyen and Fa, 2002; Heaney and Winata, 2005). Particularly, in a smaller market such as Australia, larger rms are more likely to operate internationally or have greater access to overseas capital markets than smaller companies (Heaney and Winata, 2005). Consequently, they have a greater need to use derivatives to mitigate the market risk associated with foreign currency uctuations. Prior studies have consistently found that rm size is associated with the level of disclosure in corporate annual reports (see Ali et al., 2004; Chalmers and Godfrey, 2004; Hassan et al., 2006b; Lopes and Rodrigues, 2007). Firms of differing sizes are unlikely to have the same reporting incentives. As large rms tend
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to have more resources devoted to reducing information asymmetry between managers and shareholders, they are expected to have more detailed disclosure (Hossain et al., 1995; Laksmana, 2008). Larger rms usually have other existing and potential stakeholders to satisfy with information needs, such as customers and suppliers (Inchausti, 1997). 4. Research method We investigate the use of derivatives and disclosure of nancial instruments in two stages. The rst stage involves initially examining the use of derivatives and how they relate to the range of rm characteristics documented in the previous section. The second stage involves analysing the determinants of nancial instrument disclosure. After discussing the data sources and sample, we document the use of derivatives by sample rms, including the extent and types of derivatives in use in the Australian extractives sector. Variable measures and models used in both stages of statistical tests are then outlined in sections 4.3 and 4.4, respectively. 4.1. Data and sample Sample rms are drawn from the Australian extractives industry. An initial sample of 468 companies was identied from Connect 4. We did not include companies which operate across multiple sectors. While prior research that examines nancial instrument use and disclosure is restricted to larger rms across the top 500, we examine companies across the population in this sector. Data regarding derivative nancial instrument use and disclosure are drawn from nancial reports issued in the 2008 calendar year the rst full adoption year of the new IFRS 7/AASB 7 requirements. Firms are removed for the following reasons: insucient data to undertake statistical testing (102 rms); a presentation currency other than Australian dollars (10 rms) and rms are suspended (10 rms) or delisted (ve rms) during the sample period. This leaves a nal sample of 341 rms. While we examine nancial instrument disclosure for the full sample, we document derivative use for that proportion of the sample that discloses derivative use.9 Table 1 documents the sample by sector. While many companies operate across multiple sectors in the industry, we have determined the primary extractives operations of each sample rm. The larger proportions of our sample are
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It is not always straightforward to determine whether companies use derivatives. Consistent with the ndings of Chalmers and Godfrey (2000), many companies were identied as non-users as a result of no reference to use of derivative instruments in their notes. Use of derivatives was examined by two researchers on the author team, with the results of their analysis cross-checked and reconciled prior to compiling a nal list of derivative users. 2012 The Authors Accounting and Finance 2012 AFAANZ
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Table 1 Sample by sector
Total sample (n = 341) Sector Gold Metals and minerals Coal, oil and gas Uranium Iron ore No. of rms 124 116 26 31 44 % 36 34 8 9 13
Derivative users (n = 79) No. of rms 31 23 8 8 9 % 39 29 10 10 12
involved in gold (36 per cent) or metals and minerals (34 per cent) activities, respectively. Thirteen per cent produce iron ore, while only eight per cent mine coal, oil and gas. When we consider the subsample that uses derivatives (see the discussion in section 4.2), 39 per cent of these are from the gold sector, and 29 per cent are involved in metals and minerals activities. Ten per cent of the sample that uses derivatives operate in the coal, oil and gas sector, while 12 per cent produce iron ore. Financial statements and accompanying note disclosures were examined to determine derivative use and to measure disclosure in accordance with a constructed disclosure index, with information being hand-collected from those nancial reports. 4.2. Use of derivative nancial instruments We examined the nancial statements and note disclosures in each sample rms annual report for evidence of derivative use. We found that 79 (23 per cent of the sample) of our total sample of 341 rms use derivative nancial instruments. This nding is lower than the 52 per cent industrial and 61 per cent mining derivative users reported in the Berkman et al. (2002) study. However, our study is based on the full sample of Australian extractive rms10 while the Berkman et al. (2002) study was based on a random sample of 158 rms. While 46 rms (58 per cent of the sample of 79 derivative users) documented in the notes that they use derivatives, they did not provide specic information as to the nature of these derivatives, the purpose of their use or separate nancial disclosure (refer Table 2). Many of these rms indicated they accounted for derivatives as nancial assets or nancial liabilities at fair value through prot and loss and did not separately disclose their value.
10 Few rms removed for reasons of insucient data to undertake statistical testing (102 rms); a presentation currency other than Australian dollars (10 rms); suspended rms (10 rms) and delisted (ve rms) during the sample period.

Table 2 Derivative use by sample rms Purpose Panel A: purpose of derivative use (n = 79) Hedging Speculation/trading No use specied Panel B: derivative instruments in use (n = 79) Interest rate derivatives Swaps Caps Foreign currency derivatives Forward rate agreements Options Commodity derivatives Forward rate agreements Options Swaps Caps No. of rms
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34 3 46
42 3 58
7 1 19 3 12 10 2 1
9 1 24 4 15 13 3 1
Some sample rms use a range of derivative instruments. The rms that use derivatives for speculation or trading also use them for hedging purposes.
Thirty-three rms (42 per cent of the sample of 79 derivatives users) use derivatives for hedging purposes, while three of these rms also document use of derivatives for speculation and/or trading. As would be expected of rms in the extractives sector, the most common use of derivatives is to hedge uctuations in commodity values, with foreign currency uctuations being the second most prevalent use. We note sector-specic dierences when we compare our ndings to prior research by Chalmers and Godfrey (2000) and Heaney and Winata (2005) who observe a greater use of interest rate derivatives to hedge liquidity risk. Sample rms use a range of instruments for hedging purposes, with forward rate agreements being the most common. While forward rate agreements are used across the industry to reduce the risk associated with foreign currency and commodity price uctuations, these are more likely to be used by the gold and metals and mining rms in our sample. Options for both foreign currency and commodity hedging are also frequently used. In addition, swaps and caps are used by a small proportion of rms used primarily by coal, oil and gas rms. The depth of disclosure surrounding derivative use varies substantially across the sample. Only 25 per cent of derivative users (20 rms) recognised derivative nancial instruments as separate line items in the body of their nancial statements. The extent of detail disclosed to investors on the nature of nancial risk and how it is being managed also diers. Some rms present clear detail on the nature of their activities that lead to nancial risk and how they mitigate that risk. Jabiru Metals Ltd, in the notes to its 2008 Annual Report, presents the following detail relating to commodity risk:
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J. Birt et al./Accounting and Finance 53 (2013) 5583 The Companys sales revenues are generated from the sale of copper, zinc and silver. Accordingly, the Companys cash ow is signicantly exposed to movements in the price of these metals, particularly copper and zinc. The company is entitled to 90 per cent of the value of its concentrate upon delivery into its customers storage facility (Provisional Payment). The Provisional Payment is determined by applying the average London Metal Exchange price during the month to the tonnes of payable metal in the concentrate and then deducting agreed treatment and rening charges. Upon entitlement to the Provisional Payment, the Company books 100 per cent of the revenue for that month. The remaining 10 per cent is payable upon nal settlement of each shipment. The Company adjusts the receivable for the mark-to-market movements arising from metal prices (and exchange rate) each month. The metal price the Company receives is based on the average quoted price during the quotational period. Accordingly, the Companys revenue is exposed to price variations between the time of the Provisional Payment and the nal settlement of each shipment. The markets for copper, zinc and silver are freely traded and can be relatively volatile. As a small producer, the Company has no ability to inuence commodity prices. The Company mitigates this risk through derivative instruments, including, but not limited to, quotational period hedging, forward contracts and the purchase of put options. (Jabiru Metals Ltd, 2008, pp. 4647)
Some companies disclose how they measure nancial risk; however, they do not discuss how they manage that risk. They might report the nature of risk and sensitivity analysis, as required by the accounting standard, but do not go on to explicitly discuss how this risk is managed. The 2008 Annual Report of Elemental Minerals Ltd presents a relevant example when discussing foreign exchange risk:
The company operates internationally and is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the US dollar. Foreign exchange risk arises from future commercial transactions and recognised assets and liabilities that are denominated in a currency that is not the entitys functional currency. The Australian dollar is the reporting currency for the Group and the functional currency for the parent company; however, the Groups African entities use the US dollar as a functional currency. At 30 June 2008, had the Australian Dollar weakened/strengthened by 10 per cent against the US dollar with all other variables held constant, post-tax loss from the year would not have been signicantly higher or lower, mainly as a result of the limited activity of entities in the group with the US dollar as their functional currency. Equity would have been $315,000 higher/$315,000 lower had the Australian dollar weakened/ strengthened by 10 per cent against the US dollar arising mainly as a result of the change in value of the net equity including intercompany loans of entities in the group with the US dollar as their functional currency. (Elemental Minerals Ltd, 2008, p. 43)
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Some companies take a purely monitoring approach to risk management. Kingsgate Consolidated Ltd believes it is in the interests of shareholders to expose the company to a range of nancial risks:
The Groups activities expose it to a variety of nancial risks: market risk (including currency risk, fair value interest rate risk and other price risk), credit risk and liquidity risk. At this point in the commodity price cycle, the Directors believe that it is in the interests of shareholders to expose the Group to commodity price risk, foreign currency risk or interest risks. The Directors and the management monitor these risks, in particular market forecasts of future movements in commodity prices and foreign currency movements and if it is believed to be in the interests of shareholders will implement risk management strategies to minimise potential adverse eects on the nancial performance of the Group. (Kingsgate Consolidated Ltd, 2008, p. 64)
Most rms rely on either the Board or the management team to develop and monitor hedging policy. (The use of an audit committee or risk management committee is examined later in the article.) Bass Metals Ltd, however, has taken a more formal approach by setting up a Hedge Committee consisting of the Managing Director, the Financial Controller and a Non-executive Director who is involved in nancial markets (Bass Metals Ltd, 2008, p. 51). 4.3. Variable measurement 4.3.1. Dependent variable measurement Derivative use The rst stage of the study investigates the relation between derivative use and rm characteristics. Use of derivative nancial instruments (DERIV) is measured as a dichotomous variable indicating 1, where the sample rm uses derivatives, and 0 otherwise. Financial instrument disclosure disclosure index The second stage of the study examines the relation between rm characteristics and the extent of nancial instrument disclosure. While nancial instruments includes both cash instruments (such as loans and deposits) and derivative instruments (such as interest rate swaps, forward rate agreements, currency swaps), the additional requirements in IFRS 7/AASB 7 Financial Instruments: Disclosures, which revolve heavily around discussion of risk, are more pertinent to derivative instrument users. We construct an index based on the additional requirements of IFRS 7/AASB 7 compared with the previously applicable IAS 32/AASB 132 Financial Instruments: Disclosure and Presentation, paras 51-95. We develop six categories for the index which comprises incremental disclosure of line items in the Statement of Comprehensive Income and Statement of
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Financial Position, a rms policy on nancial instruments in the notes, credit risks, liquidity risks and market risks arising from utilising nancial instruments. Points awarded consider both the existence and extent of disclosure. A total of 19 points was achievable. The six major categories, together with the points assigned to them are as follows: 1 Statement of Comprehensive Income (two points): fee income and expenses arising from nancial assets or nancial liabilities not at fair value [para 20(c)]; net gain or net loss on nancial instruments recognised in statement of comprehensive income [para 20(a)]. 2 Statement of Financial Position (two points): included as a line item (para 8) as either carrying amounts for all six categories of nancial assets and nancial liabilities11 or if the nancial instruments disclosed in the notes are the only assets/liabilities that the company has12 and includes an Age analysis of loans and receivables (para 37). 3 Policy note (three points) (paras 16, 20, 24 and 36): Extent of disclosure and description of nancial instruments as categorised according to the standards in the policy note (into the six major categories). 4 Credit risk (ve points): how companies have mitigated credit risk [para 9(b)];13 maximum exposure to credit risk [para 9(a)]; amount of change in loan or receivables attributable to credit risk [para 9(c)]; amount of change in nancial liability attributable to credit risk (para 10) and additional information about methods used to comply with paragraphs 9 and 10 (para 11). 5 Liquidity risk (two points) (para 39): Requires disclosure of maturity analysis of nancial liabilities and additional information about signicant liquidity risk exposure.
The nancial assets and nancial liabilities are (i) nancial assets at fair value through prot or loss, (ii) held-to-maturity investments, (iii) loans and receivables, (iv) availablefor-sale nancial assets, (v) nancial liabilities at fair value through prot or loss and (vi) nancial liabilities measured as amortised cost (para 8, AASB 7).
12 As an example to illustrate, A-Cap Resources Ltd only has carrying amount of investment on the balance sheet, but it shows all the nancial instruments in the notes. In such a case, one is awarded. In comparison, Aragon Resources Ltd does not mention any of the nancial instruments listed in paragraph 8 AASB 7, so zero is assigned. Besides those two cases, available-for-sale nancial assets and investments are the only nancial instruments disclosed by Bannerman Resources Ltd. As available-for-sale nancial assets and investments are the only nancial assets that Bannerman Resources Ltd has (cross-checked by referring to other in BMN notes), one is given. 13 As an example, if a company says, the group has adopted the policy of only dealing with credit worthy counterparties and obtaining sucient collateral or other securities where appropriate, as a means of mitigating the risk of nancial loss from defaults (Ferrowest Ltd nancial report, p. 50), this is not a disclosure of adequately mitigating credit risk. 11
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6 Market risk (ve points) (para 40): Four components relate to this category: (i) sensitivity analysis of each subcategory of market risk, for example, interest rate risk, foreign exchange risk and price risk; (ii) methods and assumptions of preparing the sensitivity analysis; (iii) changes in methods and assumptions since 2007 and (iv) additional information about the companys exposure to market risk. Some rms did not disclose a range of these elements because they did not utilise them. For example, sample rms that were engaged in exploration rather than commodity production and operate only within Australia had impacted by market risk to only a small extent. To take this into account, we calculate disclosure for each rm as a percentage, with the maximum scaled to take into account the rms extent of risk. Firms were required to disclose where nancial instruments had been used as collateral (para 38) or where nancial instruments had been reclassied (para 12A). We have not included these in our index, as these disclosures would only have been made if rms had these elements. We found very few of our sample companies included these (1.4 per cent). We used two steps to ensure reliability when applying the disclosure index. Initially, all members of the author team applied the index to a sample of 10 corporate reports and then compared their results. Any discrepancies were discussed, and a consensus reached on the most appropriate application. Once one researcher had completed the collection of data, a further sample of 10 reports was reviewed by a second team member to ensure the index had been applied as initially agreed. Both researchers agreed within one point in this instance. The summary statistics for the each disclosure category and for total disclosure across the disclosure index are presented in Table 2. Mean total disclosure is 57.37 per cent, and the median is 57.89 per cent. Firms in the Australian metals and mining industry disclose, on average, just over half of the items listed in our disclosure index which is based on the additional requirements of AASB 7.14 Not surprisingly, the category with the largest level of disclosure is Policy Notes, where companies disclose, on average, 70.06 per cent (median 100 per cent). This nding is a slight improvement over the results found by Lopes and Rodrigues (2007) in their analysis of IAS 132 disclosures in Portugal. One of the disclosure categories subject to the greatest level of change credit risk has a mean of disclosure of 52 per cent and maximum score of 100 per cent. The top 20 per cent of rms disclose 80 per cent (four of ve) of items listed in our disclosure index (i.e. how companies have mitigated
While our disclosure index is based on the additional requirements of AASB 7, we have allocated points for level and extent of nancial instruments disclosure. 2012 The Authors Accounting and Finance 2012 AFAANZ
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credit risk, their maximum exposure to credit risk, amount of changes in loan or receivables, amount of change in nancial liability attributable to credit risk and additional information about methods used to comply with credit risk requirements). Firms might make the decision not to fully disclose additional detailed information, and there is a possibility that such information could undermine a rms competitive advantage (Verrecchia, 1983). Sample rms met over half of the liquidity risk disclosure requirements with a mean of 61 per cent and a maximum score of 100 per cent. The disclosure level of market risk is comparable, with a mean of 59 per cent and maximum score of 100 per cent. A large proportion of rms in the extractives industry are subject to high levels of market risk from commodity price and foreign exchange uctuations, which we saw earlier is reected in the range of derivatives used by sample rms, with the top 10 per cent attaining the maximum disclosure score, and the top 30 per cent achieving a score of at least 80 per cent (four out of ve). At least two out of ve was obtained by 80 per cent of the sample rms. 4.3.2. Independent variable measurement Consistent with prior research (see, e.g. Raournier, 1995; Inchausti, 1997; Ali et al., 2004; Wei and Taylor, 2009), protability (PROF) is used as a proxy for nancial performance in this article. Protability is measured as net prot after tax divided by total assets. In addition, a market-based measure of performance is used in sensitivity tests. We use the Tobins Q ratio measured as the total market value of the rm divided by total asset value. We also use earnings per share before abnormals as a further test of robustness. A rm with high nancial risk is expected to use derivatives. The leverage ratio, dened as either debt-to-assets or debt-to-equity, is commonly used in prior studies to proxy for nancial risk (see, e.g. Wallace et al., 1994; Skaradzinski et al., 2006). In this article, we utilise debt-to-assets as a measure for nancial risk (LEV). We also use debt-to-equity (Lang and Lundholm, 1993) in robustness tests. To examine the impact of committee governance, the existence of an audit committee (AC) and a risk management committee (RMC) are measured as dichotomous variables. If a company establishes an audit committee (AC) to take on the risk management role (AC), one is assigned, and zero otherwise. If a risk management committee (RMC) is utilised, a value of one is assigned, and zero otherwise. To examine the relation between the derivative use and audit quality, a dummy variable (AUDIT) is utilised to distinguish between the engagement of a Big 4 auditor and a non-Big 4 auditor. AUDIT takes the value of one if a company is audited by a Big 4 auditor, and zero otherwise. Firm size (SIZE) is also anticipated to relate to rms disclosure practices. SIZE is measured as the log of total assets.
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4.4. Models In our study, we present two models. The initial model measures the propensity for rms to use derivative nancial instruments; hence, a binary choice logit model is used. The second model, which comprises the index based on the new disclosure requirements of IFRS 7, previously outlined, represents the determinants of nancial instrument disclosure. The initial binary-choice logit model (Model 1) testing a dichotomous measure of DERIV for the full sample of rms is as follows: DERIV fa0 b1 PROF b2 LEV b3 AC b4 RMC b5 AUDIT b6 SIZE 1 Where: DERIV = 1 if rm uses some form of derivative nancial instrument; 0 otherwise. PROF = reported net prot after tax/total assets. LEV = debt/assets. AC = 1 if the audit committee takes on the risk management function; 0 otherwise. RMC = 1 if establishment of a risk management committee; 0 otherwise. AUDIT = 1 if audited by a Big 4 auditor; 0 otherwise. SIZE = Ln (total assets). The second stage of our study examines the link between the level of disclosure, pursuant to the additional requirements of IFRS 7, and the rm characteristics previously discussed. The ordinary least-squares (OLS) linear regression model (Model 2) is constructed as follows: Disclosurei a0 b1 PROFi b2 LEVi b3 ACi b4 RMCi b5 AUDITi b6 SIZEi b7 DERIVi e
Where: Disclosure = total level of compliance with additional AASB 7 requirements for rm i. PROF = reported net prot after tax/total assets for rm i. LEV = debt/asset for rm i. AC = 1 if the audit committee takes on the risk management function; 0 otherwise for rm i. RMC = 1 if establishment of a risk management committee; 0 otherwise AUDIT = 1 if audited by a Big 4 auditor; 0 otherwise for rm i. SIZE = Ln(total assets) for rm i. DERIV = 1 if rm uses some form of derivative nancial instrument; 0 otherwise for rm i.
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5. Results 5.1. Descriptive statistics independent variables Descriptive statistics of the independent variables for the full sample are presented in Table 3. From untabulated results, SIZE, PROF and LEV demonstrate high skewness. As SIZE and LEV have large positive tails, results could potentially be biased towards large rms. The average PROFIT for our sample rms is )0.321, explained by the large number of loss rms (untabulated) 301 from the total 341 sample rms (88.3 per cent). Less than one-third of the companies are audited by Big 4 auditors. The most frequently engaged auditor is Ernst and Young, which accounts for 36 of the total sample (9.5 per cent). Only 7 per cent of rms have a risk management committee, less than that observed by Hassan et al. (2008). Audit committees were present in 56 per cent of sample rms. Finally, as previously discussed, 23.2 per cent of the sample use DERIV (Table 4). 5.2. Derivative use and rm characteristics Our rst objective is to assess the rm characteristics related to use of nancial derivatives. We conduct a binary choice logit regression with a dummy dependent variable (DERIV). Results are presented in Table 5. While we do not nd any association between our measure of nancial performance (PROF) and derivative use, we do nd that the level of nancial risk (LEV) is positively related to derivative use (p < 0.01). Financial leverage has been found in prior research (see, e.g. Smith and Stulz, 1985; Berkman et al., 2002; Nguyen and Fa, 2002; Heaney and Winata, 2005) to equate to the likelihood of nancial distress, with derivative use reducing the probability of a company entering nancial distress.
Table 3 Descriptive statistics: disclosure index Percentiles Mean SD Min. Max. 10% 20% 30% 40% 50% 60% 70% 80% 90% % % % % 44 65 70 52 61 59 57 35 0 31 0 36 0 26 0 37 0 28 0 15 16 100 100 100 100 100 100 100 0 50 0 20 0 20 37 0 50 33 20 50 40 42 0 50 67 40 50 40 47 50 50 67 40 50 60 53 50 50 100 60 50 60 58 50 50 100 60 100 60 58 50 100 100 60 100 80 63 50 100 100 80 100 80 74 100 100 100 80 100 100 79
Categories Income statement Balance sheet Policy notes Credit risk Liquidity risk Market risk Total
N 341 341 341 341 341 341 341
The table shows the extent of disclosure for each category and the total disclosure score.

Table 4 Descriptive statistics: independent variables Quartiles Variable Mean Median SD Min. Max. 25% 50%
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75%
Panel A: descriptive statistics on continuous dependent and independent variables (N = 341) PROF )0.321 )0.156 3.312 )22.628 49.841 )0.409 )0.157 )0.038 LEV 0.104 0.056 0.114 0.000 0.540 0.028 0.056 0.123 SIZE 16.481 16.361 1.400 12.178 20.036 15.456 16.354 17.280 Variable Code No. of Firms %
Panel B: descriptive statistics on categorical independent variables (N = 341) AC 0 150 1 191 RMC 0 317 1 24 AUDIT 0 250 1 91 DERIV 0 262 1 79
44.0 56.0 93.0 7.0 73.3 26.7 76.8 23.2
PROF = reported net prot after tax/ total assets; LEV = total debt outstanding/total assets; SIZE = Ln (total assets); AC = 1 if audit committee responsible for risk management, 0, otherwise; RMC = 1 if separate risk management committee, 0 otherwise; AUDIT = 1 if rms are audited by a big 4 auditor, 0 otherwise; DERIV = 1 if rm uses derivatives, 0 otherwise.
Consistent with prior research (Berkman et al., 2002; Nguyen and Fa, 2002, 2003; Heaney and Winata, 2005), rm size (SIZE) is also related to the use of derivatives. Large rms are more likely to operate internationally and therefore be subject to market risk associated with foreign currency uctuations. Neither audit quality nor committee governance relates to the use of derivatives. 5.3. Financial instrument disclosure and rm characteristics We identied that heteroscedasticity is not an issue using the White test (White, 1980). Results of the regression analysis, testing the hypothesised association between the disclosure of nancial instruments and a range of rm characteristics, are presented in Table 6. Variance Ination Factor (VIF) statistics indicate that multicollinearity is not a concern in the model. The hypothesised rm characteristics rm performance, nancial risk, audit and risk management committees, audit quality and control variables explain 20.9 per cent of variation in the level of nancial instruments disclosure. Our proposition that the level of nancial instruments disclosure is related to rm performance receives limited support at p < 0.1, in the negative direction. One factor potentially impacting our sample during the sample period is the global nancial crisis (GFC), which is likely to aect performance of sample rms
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Table 5 Determinants of derivative use DERIV = f(a0 + b1PROF + b2LEV + b3AC + b4RMC + b5AUDIT + b6SIZE + e) Model Pred. sign B SE 2.110 0.046 1.139 0.310 0.740 0.324 0.249 46.550 324.182 0.127 0.192 80.8% Wald 16.107 0.982 12.231 2.362 2.797 0.426 10.947 Sign. (p) 0.000 0.322 0.000*** 0.124 0.094* 0.514 0.001***
Constant +/) )8.470 Firm performance PROF +/) 0.046 Financial risk LEV + 3.985 Corporate governance AC + )0.477 RMC + 1.237 Audit quality AUDIT + )0.211 Firm size SIZE + 0.824 Chi-square (sig.) Log likelihood Cox and Snell R2 Nagelkerke R2 Classication table overall percentage correct
***Signicant at the 0.01 level, **signicant at the 0.05 level, *signicant at the 0.1 level. DERIV = 1 if rm uses some form of derivative nancial instruments, 0 otherwise; PROF = reported net prot after tax/ total assets; LEV = total debt outstanding/total assets; SIZE = Ln (total assets); AC = 1 if audit committee responsible for risk management, 0 = otherwise; RMC = 1 if separate risk management committee, 0 otherwise; AUDIT = 1 if rms are audited by a big 4 auditor, 0 otherwise.
during 2008, leading to this negative relationship. The large proportion of loss rms previously highlighted is also likely to contribute to this result. The prediction that disclosure of nancial instruments is positively related to nancial risk is supported at p < 0.001. The result is consistent with Wei and Taylor (2009) and Taylor et al. (2010), who found that the level of fair value and nancial risk disclosures, respectively, under a mandatory regime pursuant to IAS 32, is related to nancial risk levels. The extent of disclosure increases with escalating nancial risk, where rms with higher leverage increase disclosure to reduce potential agency costs associated with external nancing and asset substitution. We nd some support for our RMC variable (p < 0.1). Interestingly, we observe that rms with a risk management committee disclose less than those without. This result should be viewed with caution given the small proportion of sample rms which have a risk management committee an emerging governance mechanism in Australia. Risk management through the audit committees (AC) does not relate to disclosure level. However, as predicted, external audit quality (AUDIT) is positively related to disclosure at p < 0.01, indicating that rms using a higher-quality auditor provide more detailed disclosure. Big 4 auditors are more likely to have ensured

Table 6 Determinants of nancial instrument disclosure Disclosurei = a0 + b1PROFi + b2LEVi + b3ACi + b4RMCi + b5AUDITi + b6SIZEi + b7DERIVi + e Model Pred. sign Coe. 0.252 )0.004 0.281 )0.011 )0.056 0.071 0.037 0.062 SE 0095 0.002 0.067 0.016 0.030 0.018 0.014 0.019 0.211 14.081 0.000 341 t stat 2.652 )1.808* 4.193*** )0.671 )1.822* 3.944*** 2.734*** 3.339***
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VIF
Constant +/) Firm performance PROF +/) Financial risk LEV + Corporate governance AC + RMC + Audit quality AUDIT + Firm size SIZE + Derivative use DERIV + Adjusted R2 F statistics p-Value N
1.040 1.116 1.173 1.185 1.213 1.314 1.162
***Signicant at the 0.01 level, **signicant at the 0.05 level, *signicant at the 0.1 level. Disclosure = disclosure score based on level of nancial instruments disclosure for individual companies in accordance with a dened index; PROF = reported net prot after tax/total asset; LEV = total debt outstanding/total assets; SIZE = Ln (total assets); AC = 1 if audit committee responsible for risk management, 0 = otherwise; RMC = 1 if separate risk management committee, 0 otherwise; AUDIT = 1 if rms are audited by a big 4 auditor, 0 otherwise; DERIV = 1 if rm uses derivatives, 0 otherwise.
clients address the new, expanded requirements of AASB 7. The nding is again consistent with prior research by Chalmers and Godfrey (2004) and Lopes and Rodrigues (2007). The signicant SIZE variable (p < 0.01) indicates that, consistent with prior research (see, e.g. Taylor et al., 2008), large rms present more extensive disclosures of nancial instrument information. Results indicate rms which use derivatives (DERIV) have more extensive disclosures of nancial statement information (p < 0.01). 5.4. Sensitivity tests A number of sensitivity tests are conducted to check robustness of the results. We test two alternative proxies for performance: (i) a market-based measure (Tobins Q) and (ii) earnings per share before abnormals (EPS). Additionally, as an alternative proxy for leverage, debt-to-equity is used. We also introduce a
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dummy variable to the model to recognise loss-making rms. All tests revealed results consistent with the main tests previously outlined. Given coal and iron ore are the greatest exporters in the industry, and our gold rms utilise more nancial instruments than others, we also include a dichotomous control variable SECTOR to explore its relative inuence on derivative use and nancial instrument disclosure. We do not nd any association between our SECTOR control and derivative use and between SECTOR and nancial instrument disclosure. SECTOR is a relatively noisy measure, with many rms producing resources across the industry, in addition to their main product. As such, they are less likely to dier in their use of derivatives based on the nature of their production activities. 6. Conclusions, limitations and avenues for future research The objective of this article is to examine both the use of derivative nancial instruments and the level of nancial instrument disclosure subsequent to the expanded disclosure regime under IFRS 7/AASB 7 many of which are related to the risks associated with derivative use and associated fair value uctuations. We examine the relation between derivative use and nancial instrument disclosure and a range of rm characteristics for rms in the Australian extractives industry. While prior research has examined derivative use (see, e.g. Chalmers and Godfrey, 2000; Nguyen and Fa, 2002; Heaney and Winata, 2005) or the association between disclosure level of nancial instruments and rm characteristics (see, e.g. Chalmers and Godfrey, 2004; Hassan et al., 2006b; Taylor et al., 2008, 2010), this work was all conducted in either a voluntary setting or a setting subject to accounting standards with less-extensive disclosure requirements than IFRS 7/AASB 7. To examine the association between disclosure and a range of rm characteristics, a disclosure index was developed in accordance with the additional disclosure requirements in AASB 7 to measure the disclosure level. The results support the following conclusions: 1 Derivatives are used by 79 rms from our sample. While 46 of these rms did not disclose the purpose of derivative use, 33 rms use derivatives to hedge nancial risk. Commodity risk and foreign exchange risk mitigation was the most common purpose of derivatives use in our sample of extractives rms. Forward rate agreements and options are used most frequently in hedging nancial risk. The extent of detail disclosed varies greatly across sample rms. This is also reected in our disclosure index. Consistent with prior research, we also nd that derivative use is positively associated with nancial risk and rm size. 2 Firms with greater levels of disclosure of nancial instruments tend to use derivatives, are larger, less protable, more highly geared and are audited by a Big 4 rm.
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The ndings reveal several contributions of this article. First, it adds to our very limited knowledge of derivative use in the current environment and determinants of the level of nancial instrument disclosures. Second, while prior research examines the relation between the use of nancial instruments and rm characteristics in a voluntary setting (see, e.g. Chalmers and Godfrey, 2004; Lopes and Rodrigues, 2007), or in a setting prior to the release of IFRS 7 (Taylor et al., 2008; Wei and Taylor, 2009), we add to our understanding of the rm characteristics associated with disclosure of nancial instruments in a mandatory environment, that is, IFRS 7/AASB 7. Third, this study contributes to the knowledge base that standard setters can use to determine the extent to which Australian rms are disclosing derivatives under IFRS 7/AASB 7 and will assist in future directions in developing nancial instrument accounting standards. The IASB continues to make changes to reporting requirements post the GFC. As with all such research, our study is subject to some limitations. First, this article examined specically the relation between derivative use, disclosure level of nancial instruments and rm characteristics in the Australian extractives industry. This could potentially limit its generalisability to other industries. Second, the disclosure score for individual companies as well as information on independent variables are based on rms nancial reports. Therefore, the dependent and independent variables may not reect fully all of the business activities relating to use and disclosure of nancial instruments information by a rm. Third, the construction of the disclosure index utilised in this article is based on the dierence in disclosure requirements between IAS 132/AASB 132 and IFRS 7/AASB 7. Although we are condent of the inter-rater reliability in applying the index, the construction of the disclosure index in some cases requires a certain degree of discretion. Additional research could extend the time period to examine pre- and postmandatory adoption of AASB 7 to analyse the evolution of the disclosure practices and rm characteristics. Evidence of whether its adoption provides value-relevant or incremental information to stakeholders to enable them to evaluate a rms nancial instruments activities could also be gathered. Finally, future research could incorporate other accounting standards on nancial instruments, such as AASB 139 Financial Instruments: Recognition and Measurement (AASB, 2010) or the recently issued AASB 9 Financial Instruments (AASB, 2009) to the analysis. This would allow a more comprehensive examination of nancial instrumentsrelated issues, and most importantly the fair value of derivatives. References
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Accounting and Finance 53 (2013) 5583

Derivatives use and nancial instrument disclosure in the extractives industry

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

Derivative users (n = 79) No. of rms 31 23 8 8 9 % 39 29 10 10 12

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

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2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

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J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

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J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

J. Birt et al./Accounting and Finance 53 (2013) 5583

2012 The Authors Accounting and Finance 2012 AFAANZ

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