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Economic Consequences Of Off-Balance Sheet Financing:The Case Of Equity Method Investments
Suning Zhang,
George Mason University
ABSTRACT. This paper studies the determinants and consequences of one type of off-balance sheet arrangement--equity method investments. Consistent with theoretical predictions that off-balance sheet financing leads to economic efficiency, the results show that firms are more likely to undertake equity method investments when agency costs of debt, information asymmetry and risk-shifting incentives are higher. On the other hand, my results are not consistent with managerial opportunism as a motivation for undertaking equity method investments. I also find that equity method investments result in improvement in operating performance and firm value. Further, I find that, while on average investors correctly assess the off-balance sheet risks associated with equity method investments, they appear to underestimate the risk exposure of companies who guarantee the off-balance sheet entity’s debt. Overall, the results support the hypothesis that off-balance sheet arrangements lead to economic efficiency.
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