Discussion of Firms' Off-Balance Sheet and Hybrid Debt Financing: Evidence from Their Book-Tax Reporting Differences

摘要

By comparing interest expense for tax reporting purposes with interest expense for financial reporting purposes, Mills and Newberry are able to infer the extent to which a firm engages in off-balance sheet financing arrangements. This use of confidential tax return data is novel in that it allows for the examination of financing activity that otherwise would be difficult or impossible to examine using public financial reporting data. The key empirical result is that the use of off-balance sheet financing is greater in firms with weak debt ratings and in firms with performance pricing arrangements in their debt. In addition, management of debt covenants appears to play a role in the use of off-balance sheet financing. My main quibble with Mills and Newberry's study is that it stops short of addressing the more fundamental issues regarding off-balance sheet financing. The rich data set could be used to address the broader question of whether off-balance sheet financing allows firms to obscure their financial condition from rating agencies and investors, in particular, the extent of their leverage. If financial statements do not reflect firms' obligations, and the ratings agencies and investors are not able to fully discern the obligations and risks in off-balance sheet financing, the result could be suboptimal allocation of resources by the capital markets. Obviously this is an empirical question. Although there has been much speculation and action by policy makers, rigorous empirical evidence on this issue is in short supply.