Classification of Financial Instruments with Characteristics of Both Debt and Equity: Evidence Concerning Convertible Redeemable Preferred Stock (Manuscripts‪)‬

ABSTRACT This study examines the market perception of a compound financial instrument, convertible redeemable preferred stock (CRPS). CRPS has the form of preferred stock, but also possesses a redemption feature and a conversion feature. Accounting for such instruments is the subject of a pending exposure draft by the Financial Accounting Standards Board. Current accounting rules for CRPS require that it be excluded from equity, but not classified as debt. A sample of firms reporting CRPS for fiscal years 1991 through 1995 is examined using a levels approach. The findings suggest that the market perceives CRPS as debt in two out of the five years under study. In the other three years the evidence is less convincing, raising the question as to whether current accounting rules classify CRPS according to how it is perceived by investors. The results would appear to support the FASB's decision to consider a new accounting standard for instruments with characteristics of both debt and equity. This study is timely and sheds light on an issue under deliberation by accounting standard setters.