Special Purpose Vehicles: Empirical Evidence on Determinants and Earnings Management

Abstract

We investigate the use, determinants, and earnings effects of special purpose vehicles (SPVs). Based on a proxy of SPV activity that can be applied to a broad cross-section of firms over time, we find a two-and-a-half fold monotonic increase in the percentage of firms using at least one SPV during the eight-year period from 1997 through 2004. Tobit regressions of the determinants of SPV use show that SPV activity increases with financial reporting incentives and economic and tax motivations, but strong corporate governance tends to mitigate their use. In addition, the evidence is consistent with SPVs arranged for financial reporting purposes being associated with earnings management, whereas the same does not appear to be the case for SPVs set up mainly for economic, tax, and other reasons.

Implications of FIN 46 for Accruals Quality and Investment Efficiency

“…The mean SIZE of group 1 and group 2 are 7.693 and 7.858 respectively, while the mean size of group 3 is 5.173. This is consistent with the fact that firms with SPEs (VIEs) are usually larger firms since they have better technical expertise to handle the complex financing arrangement (SEC 2005;Feng 2009). The mean LEVERAGE is 0.628 for group 1, 0.632 for group2, and 0.568 for group 3.…”

“…By using SPEs, firms gain more flexibility to manage reported earnings and debts since sponsoring firms control both entities. Prior studies provide evidence that firms manage earnings by using off-balance sheet items (e.g., Dechow and Shakespeare 2009;Feng et al 2009;Dechow et al 2010). Dechow and Shakespeare (2009) reporting.…”

“…Dechow and Shakespeare (2009) find that firms manage earnings by timing securitizations of assets by using SPEs. Feng et al (2009) document that SPEs created for financial reporting purposes are more likely to be used to manage earnings. Their tests all focus on the pre-FIN 46 periods.…”

Whether Sensible Business Tool or Deceptive Scheme to Conceal, the Special Purpose Entities Are here to Stay

“…The major reason that this has held to be the case lies in the fact that these entities are pass-through entities for tax purposes. Thus, SPEs are created as pass through entities "to afford maximum flexibility in allocating tax benefits to those investors that can best use them" (Feng 2009). Because of this widely known fact, we believe our SPE identification on Form 10-K will be reasonably accurate.…”

The Relation Between Voluntary Disclosure and Financial Reporting: Evidence from Synthetic Leases

“…For example, an article highlights the concerns surrounding a potential U.S. auto manufacturer bankruptcy with the title, "Fear of a Worthless Car Warranty: Shoppers Are Worried About Buying a Domestic Car for Fear the Company They Bought It from Will Go Under" (CNNMoney.com, December 12, 2008). 8 There is little evidence to support firms' use of off-balance-sheet activities to influence equity market perceptions (e.g., Beatty, Berger, and Magliolo [1995], Feng, Gramlich, and Gupta [2009]). While there is mixed evidence that compensation and debt contracts are associated with the decision to use off-balance-sheet activities (e.g., Shevlin [1987], Beatty, Berger, and Magliolo [1995], Altamuro [2006], Feng, Gramlich, and Gupta [2009]), it is difficult to argue that these contracts capture a hidden information problem as the board of directors and lenders generally have access to private information.…”