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The economic consequences of the Statement of Financial Accounting Standards (SFAS) No. 150.

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Abstract

SFAS No. 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS 150), requires companies to report mandatorily redeemable preferred stock (MRPS) as a liability, and the dividends on these securities as interest expense. The purpose of this study is to examine the economic consequences of SFAS 150's adoption on a sample of public companies. Our analysis indicates that adoption resulted in both intended and possible unintended economic consequences. Specifically: (1) the impact of SFAS 150 on non-public companies caused the FASB to review its position on the disclosures concerning MRPS; (2) some companies redeemed their MRPS prior to the adoption date of the standard; and (3) approximately 4% of sample firms were required to disclose MRPS as a liability. (JEL M41)

Keywords: economic consequences, Financial Accounting Standards Board, mandatorily redeemable preferred stock, SFAS 150

Introduction

The economic consequences of accounting standards have been a topic of interest for over two decades. 'Economic consequences' refer to the impact of accounting reports on various segments of our economic society [Zeff, 1978, p.56]. Since the identification of this issue, there have been a number of studies that have investigated the economic consequences of accounting standards [Guay et al., 2003; Dechow et al., 1996; Khurana and Loudder, 1994; Wasley and Linsmeier, 1992; Stone and Ingram, 1988].

Economic consequences may be intended or unintended. Consider the release of Financial Accounting Standards Board Statement No. 106, "Other Post Retirement Benefits" (SFAS No. 106, 1985). This release required companies to change from a pay-as-you-go basis to an accrual basis for health care and other benefits that companies provide to retirees and their dependents. The intended economic consequences of this standard were the disclosures of annual estimated costs for future employee health care obligations as current expense. However, the release of SFAS 106 also had unintended economic consequences in that many companies simply ceased providing such benefits to their employees, at a large social cost.

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS 150, 2003). This pronouncement requires companies to record and report mandatorily redeemable preferred stock (MRPS) as a liability on their balance sheet and the dividends on these securities as interest expense. Most companies previously disclosed MRPS between the liability and stockholders' equity sections (i.e., the mezzanine section) of the balance sheet.

At the time of SFAS 150's adoption, concern was voiced over the economic consequences to those firms impacted by its provisions, and there had been speculation in the financial press and by companies that compliance with SFAS 150 could cause some companies to be in default of their debt covenants or to experience large increases in interest costs [McCarthy et al., 2004]. For example, shortly after SFAS 150 was released, AOL Time Warner's third quarter SEC...

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