Ceteris Paribus? Variable Interest Entity (VIE) Consolidation Under FIN 46R

Abstract:     
In this study, we examine how investors and analysts decipher the complexities of structured finance vehicles under different accounting rules which afford discretion to management with respect to the quantitative risk criteria used for on- or off-balance sheet classification. In particular, in contrast to findings in prior literature, we provide evidence that during the 2003-2007 period, consolidated variable interest entities (VIEs) were associated with more equity risk than unconsolidated VIEs, suggesting that, on average, investors inferred a meaningful difference between classifications of VIEs as determined by managers under FIN 46R. Consistent with consolidation of VIEs reducing uncertainty about the implications of VIE activities for firms, consolidated VIEs were associated with less information asymmetry than unconsolidated VIEs, suggesting that analysts acknowledged the potentially hidden risks of these vehicles. Further, our results are consistent with ex-ante incentives for consolidation related to managing credit quality, e.g., the unconsolidated VIEs of highly levered firms are shown to be riskier and more opaque. However, despite these incentives, stakeholders are able to assess VIE risk and opacity for firms with high earnings quality. Lastly, consistent with the FASB's intention, SFAS 166 appears to have increased the transparency of structured finance vehicles.

Number of Pages in PDF File: 42

Keywords: Consolidation, securitization, off-balance sheet, variable interest entity, VIE, FIN 46R, SFAS 140, SFAS 166

JEL Classification: G14, G21, M41

working papers series