The Credibility of Accounting Classification: Determinants and Consequences

31 Pages Posted: 4 May 2003

See all articles by Frank D. Hodge

Frank D. Hodge

University of Washington - Michael G. Foster School of Business

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting

Jamie H. Pratt

Indiana University - Kelley School of Business - Department of Accounting

Date Written: March 14, 2003

Abstract

In this study we report the results of a laboratory experiment in which we examine whether the credibility of management's balance-sheet classification of hybrid securities as liabilities or equity is a joint function of (1) the level of classification discretion in the reporting environment, (2) whether management's classification choice is consistent or inconsistent with reporting incentives, and (3) management's reporting reputation. Our results suggest that when classification is mandated, credibility is unrelated to management's reporting reputation and whether management's classification choice is consistent or inconsistent with incentives. When classification is discretionary, financial report users consider management's classification choice more credible when it is inconsistent with incentives. Users are sensitive to management's reporting reputation only when classification is discretionary and management's classification choice is consistent with incentives. We also find that the association between the credibility of management's classification choice and user assessments of financial performance depends upon whether the classification is consistent or inconsistent with incentives. Finally, our results suggest that a good reporting reputation leads to higher financial performance assessments in both mandated and discretionary reporting environments. Implications, limitations, and future research are also discussed.

Keywords: credibility, financial reporting reputation, discretionary disclousre, hybrid securities, financial statement analysis

JEL Classification: D80, M41, M45, L14

Suggested Citation

Hodge, Frank Douglas and Hopkins, Patrick E. and Pratt, James H., The Credibility of Accounting Classification: Determinants and Consequences (March 14, 2003). Available at SSRN: https://ssrn.com/abstract=391140 or http://dx.doi.org/10.2139/ssrn.391140

Frank Douglas Hodge (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Paccar Hall 540, Box 353200
Seattle, WA 98195-3200
United States
206-616-8598 (Phone)
206-685-9392 (Fax)

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting ( email )

Kelley School of Business
1309 E. 10th Street
Bloomington, IN 47405
United States
812-855 2617 (Phone)
812-855 8679 (Fax)

James H. Pratt

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2657 (Phone)
812-855-8679 (Fax)

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