Management Reaction to Mandatory Accounting Changes: The Canadian Preferred Shares Case

Abstract:     
The new Canadian accounting standards for financial instruments require that retractable preferred shares be classified as debt, thus negatively affecting the debt/equity ratio. Previous research, most of which has examined the impact of a change in American accounting standards affecting the determination of earnings, indicates that firms with such shares will act to mitigate the negative impact of the accounting change on their financial statements. Specifically, firms are likely to: a) reduce the amount of retractable preferred shares outstanding, and/or b) reduce the amount of other liabilities, and/or c) increase the amount of equity outstanding.

I test these predictions using data on firms required to file information on their preferred shares with Canadian securities commissions. Evidence based on a sample of 34 such firms indicates that they did indeed reduce the amounts of both retractable preferred shares and the amounts of other liabilities and issued additional common shares. Surprisingly, smaller firms did not make greater reductions (as a proportion of total assets) than larger firms.

Number of Pages in PDF File: 30

JEL Classification: M41, G32

working papers series