This paper has benefited significantly from the comments of Shane Dikolli, Michelle Hanlon, Karim Jamal, Ross Jennings, Bill Kinney, Lisa Koonce, Tom Scott, Senyo Tse and Connie Weaver as well as from workshop participants at the University of Alberta and the 2002 University of Texas at Dallas Accounting and Finance Symposium.
Debt Reclassification and Capital Market Consequences
Article first published online: 7 APR 2006
Journal of Business Finance & Accounting
Volume 33, Issue 7-8, pages 1189–1212, September/October 2006
How to Cite
Gramlich, J. D., Mayew, W. J. and McAnally, M. L. (2006), Debt Reclassification and Capital Market Consequences. Journal of Business Finance & Accounting, 33: 1189–1212. doi: 10.1111/j.1468-5957.2006.00593.x
- Issue published online: 27 APR 2006
- Article first published online: 7 APR 2006
- (Paper received January 2005, revised version accepted July 2005. Online publication April 2006)
- debt classification;
- economic consequences;
- debt ratings;
- market value of equity
Abstract: We provide initial evidence on the economic consequences of a relatively large, fully disclosed, and apparently purposeful reporting decision: the balance sheet classification of short-term obligations as long-term debt in accordance with Statement of Financial Accounting Standard No. 6. We examine a sample of 1,684 American firm-year observations between the years 1989 and 2000 to determine whether reclassification is associated with debt-ratings and equity values. We find that reclassification increases the likelihood of a subsequent debt-rating downgrade. We also find that market value decreases with increases in the amount reclassified, and that equity value is higher after firms cease reclassifying short-term obligations as long-term debt, compared with other firm-years in the sample. Thus, changes in debt classification are empirically linked in predictable directions to subsequent changes in debt ratings and stock values. Taken together, our results show that debt classification is an important publicly-available indicator that may be useful to capital market participants. We discuss several research extensions including the implications of our findings to European companies that convert to IAS in 2005.