Establishing the Common Stock Equivalence of Convertible Bonds.

Abstract ABSTRACT: The identification of common stock equivalents is necessary to compute primary earnings per share. However, the APB/FASB rules for classifying convertible securities as common stock equivalents lack a well-defined rationale. This paper describes a periodic market-based statistical test to establish common stock equivalence for convertible bonds. The test is consistent with the APB's stated intent and is based on the theoretical valuation of convertible bonds. It is compared with the classification rules of the APB/FASB for common stock equivalents using a randomly selected sample of convertible bonds. There is little agreement between the convertible bonds classified as common stock equivalents by the APB/ FASB rules and those so classified by the market-based test described herein.