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Debt Reclassification and Capital Market Consequences

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  • Jeffrey D. Gramlich
  • William J. Mayew
  • Mary Lea McAnally

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. Copyright 2006 The Authors Journal compilation (c) 2006 Blackwell Publishing Ltd.

Suggested Citation

  • Jeffrey D. Gramlich & William J. Mayew & Mary Lea McAnally, 2006. "Debt Reclassification and Capital Market Consequences," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(7-8), pages 1189-1212.
  • Handle: RePEc:bla:jbfnac:v:33:y:2006-09:i:7-8:p:1189-1212
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    References listed on IDEAS

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    1. Keith Cuthbertson & Dirk Nitzsche & Niall O' Sullivan, 2004. "UK Mutual Fund Performance: Genuine Stock-Picking Ability or Luck," Money Macro and Finance (MMF) Research Group Conference 2004 55, Money Macro and Finance Research Group.
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    Cited by:

    1. Bischof, Jannis & Ebert, Michael, 2007. "IAS 39 and biases in the risk perception of financial instruments," Papers 07-73, Sonderforschungsbreich 504.
    2. Bischof, Jannis & W├╝stemann, Jens, 2007. "How does fair value measurement under IAS 39 affect disclosure choices of European banks?," Papers 07-75, Sonderforschungsbreich 504.

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