The Impact of SFAS 160: An Investigation of the Economic Consequences of the Reclassification of Minority Interest

Abstract

We examine firms’ behavior around the adoption of SFAS 160 to provide evidence on the costs and benefits associated with mandated accounting changes. The reclassification of minority interest to equity mandated by SFAS 160 can result in a wealth transfer from bondholders to stockholders. However, lenders can limit this transfer by renegotiating agreements. Consistent with these conjectures, we find that the abnormal returns surrounding the release of SFAS 160 are increasing with the level of minority interest, but decreasing for firms in the highest tercile of long-term debt. To provide direct evidence of re-contracting, we examine lending agreements for exclusions of minority interest from net worth but do not find an increase in new exclusions after SFAS 160. We also examine whether firms’ choice to include minority interest as a liability prior to SFAS 160 is related to firms’ stock returns at the release of SFAS 160. We expect and find a negative relation between the decision to classify minority interest as a liability and the stock return, but the relation is not statistically significant. We find that firms with minority interest following IFRS exhibit higher stock returns suggesting these firms benefit from increased congruence with U.S. GAAP. Finally, we examine post-160 changes in merger activity and find that firms did not exploit the provisions of SFAS 160 to increase debt covenant slack by engaging in a higher proportion of partial acquisitions ex post. We conclude that existing shareholders of firms with minority interest benefited from SFAS 160, but wealth transfers from bondholders were not sufficient to warrant alteration of debt contracts nor were such benefits sufficient to alter the structure of acquisition transactions.

JEL Classification: M44, M41