Economic Consequences of Financial Reporting Changes: Diluted Eps and Contingent Convertible Securities

Abstract

This paper examines the economic consequences of changes in the financial reporting requirements for contingent convertible securities (COCOs). Using a sample of 199 COCO issuers from 2000-2004, we find that issuers are more likely to restructure or redeem existing COCOs to obtain more favorable accounting treatment when the financial reporting impact on diluted earnings per share (EPS) is greater and when EPS is used as a performance metric in CEO bonus contracts. These results provide new evidence that managers are willing to incur costs to retain perceived financial reporting and compensation benefits. We also present evidence of significantly negative stock returns around event dates associated with the financial reporting changes, consistent with investor anticipation of the agency costs associated with the rule change.

Keywords: Economic consequences, agency costs, diluted EPS, executive compensation, convertible securities

JEL Classification: M41, M45, J33, G12, G38