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Debt Reclassification and Capital Market Consequences

Authors

  • Jeffrey D. Gramlich,

    1. The authors are respectively, from the University of Southern Maine and Copenhagen Business School; the University of Texas at Austin; and Texas A&M University.
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  • William J. Mayew,

    1. The authors are respectively, from the University of Southern Maine and Copenhagen Business School; the University of Texas at Austin; and Texas A&M University.
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  • Mary Lea McAnally

    Corresponding author
    1. The authors are respectively, from the University of Southern Maine and Copenhagen Business School; the University of Texas at Austin; and Texas A&M University.
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  • 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.

* Address for correspondence: Mary Lea McAnally, Accounting Department, Mays Business School, Texas A&M University, College Station, TX 77843, USA.
e-mail: MMcAnally@mays.tamu.edu

Abstract

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.

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