An Examination of the Cost of Capital Implications of FIN 46

Abstract

This study examines whether the adoption in 2003 of FASB Interpretation No. 46/R (FIN 46), Consolidation of Variable Interest Entities—An Interpretation of ARB No. 51, changed the cost of capital for affected firms. Using comparative analysis on a broad sample of 11,719 firm-quarter observations for 1,389 firms during the period 1998 through 2005, we find evidence that FIN 46 significantly increased the cost of equity capital for firms with affected variable interest entities (VIEs), an increase of approximately 50 basis points relative to firms reporting no material effect from the standard. Further, firms consolidating these formerly off-balance sheet structures experienced the largest increase. Taken together, these results suggest that FIN 46 reduced the opportunity for firms to use off-balance sheet structures to artificially reduce their cost of capital, a matter of regulatory concern. Data Availability: All data are available from public sources.

Tax avoidance and ex ante cost of capital

“…In both Models (1a) and (1b), our dependent variable is AvgPremium . Consistent with prior literature (Callahan, Smith, & Wheeler Spencer, ; Daske, Hail, Leuz, & Verdi, ; Dhaliwal, Heitzman, & Li, ; Dhaliwal, Krull, Li, & Moser, ; Hail & Leuz, ; Hutchens & Rego, ), we calculate AvgPremium using an average of four ex ante cost of equity capital measures from Claus and Thomas (), Easton (), Gebhardt, Lee, and Swaminathan (), and Gode and Mohanram (). We estimate this measure as of June 30 following the close of the fiscal year.…”

The Economic Effects of Special Purpose Entities on Corporate Tax Avoidance

“…6 Second, from a financial reporting perspective, "bright-line" tests in ARB No. 51 (AICPA 1959) made it relatively easy for sponsors to avoid the consolidation of SPEs (Soroosh and Ciesielski 2004;Callahan et al 2012Callahan et al , 2013. 7 As a result, SPEs became a popular way to move debt, expenses, and high-risk assets off-balance sheet to enhance profitability and reduce perceptions of risk.…”

Implications of FIN 46 for Accruals Quality and Investment Efficiency

“…The coefficient for the interaction term (β indicates whether the accrual quality changed for firms affected by To test H2, I divide FIN 46 firms into two groups: firms consolidating VIEs (FIN46_CON) and firms keeping VIEs off the books (FIN46_OFF) following the approach used in Callahan et al (2012), and test the change in accrual quality between these two groups. The sample includes all the three groups of firms.…”

“…To identify those firms I follow the approach used by Callahan et al (2012). To test hypotheses I form three groups with sample firms depending on the effects of FIN 46 on those firms.…”

“…First, my study adds to the literature on the impact of FIN 46 on financial reporting. Prior studies investigate the economic consequences of FIN 46 from the perspective of market participants' responsiveness such as cost of capital (Callahan et al 2012), analyst forecast precision, and earnings response coefficients (Gurun et al 2012). While these studies largely assume that the implementation of FIN 46 enhances financial reporting transparency and deters earnings management, no extant research examines the impact of the changes in SPE consolidation rules on the quality of reported accounting numbers.…”