Market Pricing and the Disclosure Compliance of the Reclassification Rules for Financial Instruments

Abstract

Most of the firms adopting the second amendment of TFAS 34 reclassify financial assets held for trading to available for sale. There are 15 firms violate the disclosure requirements regarding the reclassification of financial assets, while the rest of the sample firms are fully compliant with the requirements. In addition, our empirical results show: (1) the explanatory power of the models using accounting information as reported is greater than that of the models using accounting information assuming no-reclassification and the difference is statistically significant, and (2) the empirical results for the total sample and the negative-to-negative sub-sample, which consist of firms with negative abnormal earnings (or negative earnings after tax, or negative earnings before tax) both before as well as after the reclassification, are the same. Investors’ valuation of the income effects from reclassification is significantly different from other earnings components. Though the income effects from reclassification is value relevant, the investors’ valuation of the disclosed reclassification effects (losses) is significantly positively. Overall, the empirical results are consistent with the “limited attention” and the “functional fixation” hypotheses. Investors seem to fixate on the earnings as reported.