An Empirical Analysis of Risk and Liability Components

55 Pages Posted: 18 Jan 2011

See all articles by C.S. Agnes Cheng

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance

Cathy Zishang Liu

affiliation not provided to SSRN

Kenneth John Reichelt

Louisiana State University, Baton Rouge - Department of Accounting

Date Written: January, 12 2011

Abstract

This paper documents the association between market risk measures and leverage components of a firm’s capital structure over the last four decades. High leverage increases risk to common stockholders; however, the definition of a liability reported on the balance sheet has been the subject of debate in recent years. Motivated by the ongoing joint project between the IASB and the FASB on defining equity and liability and an inconclusive decision on the definition of preferred stock, this paper documents how the market has perceived various liability components, (i.e., as debt or equity), including preferred stock, on the right-hand side of the balance sheet. We find that common shareholders perceive higher proportions of preferred stock to assets as risky. In addition to debt, we also find our model works for capital leases and deferred taxes: we confirm that the market perceives higher proportions of capital leases as risky and deferred taxes as equity-like. To facilitate standards setting, it is important to document the views from market participants (Barth et al. 2001). Our study has important implications for the classification of financial instruments with components of debt and equity.

Keywords: Leverage Components, Preferred Stock, Risk Measures

JEL Classification: M41

Suggested Citation

Cheng, C.S. Agnes and Liu, Cathy Zishang and Reichelt, Kenneth John, An Empirical Analysis of Risk and Liability Components (January, 12 2011). CAAA Annual Conference 2011. Available at SSRN: https://ssrn.com/abstract=1739316 or http://dx.doi.org/10.2139/ssrn.1739316

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon, Kowloon
Hong Kong

Cathy Zishang Liu

affiliation not provided to SSRN

Kenneth John Reichelt (Contact Author)

Louisiana State University, Baton Rouge - Department of Accounting ( email )

2821 Business Education Complex
Baton Rouge, LA 70803
United States
225-578-6233 (Phone)

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