How Do Experienced Users Evaluate Hybrid Financial Instruments?

Abstract

Hybrid financial instruments contain features of both liabilities and equity. Standard setters continue to struggle with “getting the classification right” for these complex instruments. In this paper, we experimentally test whether the features of hybrid instruments affect the credit‐related judgments of experienced finance professionals, even when the hybrid instruments are already classified as liabilities or equity. Our results suggest that getting the classification right is not of primary importance for these experienced users, as they largely rely on the underlying features of the instrument to make their judgments. A second experiment shows that experienced users’ reliance on features generalizes to several features that often characterize hybrid instruments. However, we also find that experienced users vary in their beliefs about which individual features are most important in distinguishing between liabilities and equity. Together, our results highlight the importance of effective disclosure of hybrid instruments’ features.

Who likes jargon? The joint effect of jargon type and industry knowledge on investors’ judgments

“…10 Our measure for investment willingness is a widely used variable in prior behavioral accounting papers. See Clor-Proell et al (2016) and Tang and Venkataraman (2018) for examples. the dependent variable.…”

“…With respect to investors with some-but-low industry knowledge, as discussed in our theory section, they are more likely to rely on heuristic cues to make judgments. More particularly to an IPO setting, since management is motivated to reduce information asymmetry in order to reduce IPO underpricing, investors may infer that management's use of jargon is inconsistent with their incentives at IPO and conclude that management is correspondingly more credible (Koonce et al, 2016). Thus, investors with some-but-low knowledge will perceive managers to be more credible with more jargon used in the IPO prospectus.…”

Accounting for financial instruments with characteristics of debt and equity: finding a way forward

“…Clor‐Proell et al . () used an experiment to test how experienced US finance professionals incorporated disclosed features of compound financial instruments in credit‐related judgements. The authors concluded that the accounting classification does not significantly influence these users; their judgements are largely dependent on the underlying features of the instrument.…”

“…Clor‐Proell et al . () also examined the use of information on priority in liquidation, voting rights, settlement in cash versus shares and dependence on profitability for payments to holders. They found that experienced users vary in their beliefs about which individual features are most important in distinguishing between liabilities and equity, pointing to the importance of disclosure.…”

Evaluation of the Classification of Liabilities or Equity on Convertible Bond Issuance Transactions at PT ABC

“…Some other research also finds that for the finance professionals, getting the classification right is not as important as not getting it wrong because they rely on the instrument's underlying features to make their decisions. In contrast, finance professionals differ in their opinion on which individual characteristics are most critical to determining the difference between both liabilities and equity (Clor-Proell et al, 2016); in the other case, the classification decision will impact the firm, as after the prerequisite that firms classify the mandatory conversion preferred stock hybrid instrument as a liability, the share of issuer firms' new financing declined (Levi & Segal, 2015).…”