AAA Spark Meeting of Regions

Consolidation of Off-Balance Sheet Entities and Investment Efficiency

• In Event: Non-GAAP Earnings Reporting and Earnings Management

Abstract

This study examines the effect of consolidating off-balance sheet entities on firm-level investment efficiency. FASB Interpretation No.46, Consolidation of Variable Interest Entities—An Interpretation of ARB No.51 (FIN 46) is used as a quasi-exogenous shock to financial reporting in this study. We empirically test the change of investment efficiency for a sample of firms affected by FIN 46 in the post-FIN 46 period. In the regression, a group of matched pairs selected from unaffected firms is used as the control sample and firm characteristics are used as control variables. We find that firms affected by FIN 46 experience improvement in investment efficiency after adopting the standard compared to unaffected firms. We also document that the post-FIN 46 improvement in investment efficiency is primarily attributable to the reduction in over-investment. Further analyses show that among the affected firms, firms consolidating off- balance sheet special purpose entities improve investment efficiency mainly by reducing over-investment, whereas firms avoiding the consolidation of special purpose entities don’t display such tendency. This study contributes to the literature on the relation between financial reporting and investment efficiency as well as the literature on the impact of FIN 46. To the best of our knowledge, this study is the first to examine the relation between the consolidation of off-balance sheet entities and investment efficiency.

Authors

• Fang Zhao, Merrimack College

• Abhijit Barua, Florida International University

• Jung Hoon Kim, San Francisco State University