Credit Risk and Off-Balance-Sheet Contractual Obligations: Disclosures under Rule FR-67

• In Event: Financial Accounting and Reporting 6

Abstract

To increase transparency in financial reporting and to promote a better understanding of companies’ offbalance
sheet obligations, the Securities and Exchange Commission (SEC) issued Final Rule No. 67 (FR-
67) to mandate a tabular disclosure of all known on- and off-balance sheet contractual obligations in a
single location within the Management’s Discussion and Analysis (MD&A) from 2003. Using a sample
of S&P 1500 companies, I examine whether the disclosures under Rule FR-67 influence the assessment
of credit risk by credit rating agencies, public bond holders, and private loan lenders. I find that all four
credit risk measures (i.e., credit ratings, negative credit watch, bond spreads, and the number of covenants
in private loan contracts) significantly increase with off-balance sheet obligations when the firms report
the tabular disclosures of contractual obligations for the first time. My results also suggest that the credit
rating agencies and public bond holders view both the purchase obligations and other types of off-balance
sheet obligations as equally relevant to firms’ credit risk, while the private loan lenders view purchase
obligations as more relevant. This evidence should be of interest to regulators, investors, and creditors in
addressing the present debate about to what extent off-balance sheet items should be recognized on the
balance sheet.

Author

• Sha Zhao, Baruch College, CUNY