Off Balance Sheet Arrangements Using Special Purpose Vehicles and Stock Price Crash Risk

Project: Research

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The proposed research aims to provide systematic evidence on the firm-level relation between the use of Special Purpose Vehicles (SPVs) and stock price crash risk. An SPV is a legally distinct entity with a limited life created for a special purpose to carry out limited activities for a ‘‘sponsor’’ company. SPVs were originally created to serve the purpose of economic benefits such as lowering financing costs. However, investigations on Enron and other Enron style corporate scandals find that firms have been using SPVs in financial statement window-dressing. When a sponsor company avoids consolidating the SPV in its financial statements, it can improve its balance sheet by reporting less debt and its income statement by reporting higher earnings. For example, in a typical sale-leaseback transaction, the SPV borrows money to purchase the sponsor’s fixed asset. Then the sponsor leases the asset back from the SPV under operating lease. These transactions first help the sponsor reduce leverage by not consolidating the SPV’s borrowing in its balance sheet, and second facilitate the sponsor in managing earnings by recognizing gains on the sale and controlling the timing and amount of the lease payments.When management engages in earnings management to conceal bad news and overstate performance, bad news will be stockpiled within the firm. The complex structure and insufficient disclosures on SPVs facilitate managers withholding and accumulating bad news. However, there is an upper limit to the amount of bad news that managers can absorb. Once the amount of accumulated bad news reaches the upper limit, it will come out at once, leading to large, negative, price movements - stock price crashes. Our primary research objective is to test the hypothesis that SPV use increases the likelihood of future crash occurrences. In addition, we also aim to provide evidence on whether effective external monitoring mechanisms can mitigate the effect of SPV use on crash risk and whether firms that have foreign SPVs have even greater crash risk.While case analyses on Enron and others show that SPV use has caused their collapse, there is a lack of evidence on whether SPV use in general is associated with higher crash risk. The proposed research, to the best of our knowledge will be the first to provide general results on this broader issue using large sample analyses. The results will offer important policy implications for accounting regulations in the US, China and other economies.


Project number9041719
Grant typeGRF
Effective start/end date1/01/125/03/14