The Impact of Debt-Equity Reporting Classifications on the Firm's Decision to Issue Hybrid Securities

Abstract

We test the influence of classification of securities into liabilities and equity on firms' financing choices, using as our setting the change in reporting classification of hybrid securities following SFAS 150. We find that this change affected the decision of firms to issue mandatorily redeemable preferred shares (MRPS). Following the requirement that firms classify the debt-like hybrid security MRPS as a liability, the share of MRPS issuances in firms' new financing declined. Characteristics of firms issuing MRPS also changed. While prior to SFAS 150 firms with higher levels of debt and lower coverage ratios chose to issue MRPS and not debt, after its adoption, the decision to issue MRPS is no longer related to firms' pre-existing debt and coverage levels. Furthermore, our results indicate that before SFAS 150 managers were willing to bear the higher issuance fees of MRPS and chose to issue these debt-like hybrid securities over cheaper debt. The requirement to classify debt-like hybrids as a liability took away the reporting incentives for issuance and made these securities a less popular financing vehicle.