Special Purpose Entities: Empirical Evidence on Determinants and Earnings Management

Abstract

This paper investigates the usage, determinants and earnings effect of special purpose entities based on a large sample of firms from 1994 to 2004. We find that SPE use has grown substantially in recent years and that the number of SPEs is related to economic motivations, financial reporting objectives and corporate governance. Specifically, SPE use is significantly higher for firms with greater need for funds and higher marginal tax rate. We also find that SPE use increases with closeness to debt covenants, CEO's bonus and weak corporate governance. Finally, we document that the evidence is consistent with SPEs set up for financial reporting purposes playing a role in managing accruals and earnings upwards, whereas the same does not appear to be the case for SPEs set up mainly for economic reasons.

Keywords: off-balance sheet, special purpose entities, leverage, accruals, return on equity

JEL Classification: G32, G39, M41, M43, H25