An Examination of the Cost of Capital Implications of Financial Interpretation 46

Abstract

This study examines whether adoption in 2003 of FASB Interpretation No. 46/R (FIN 46), Consolidation of Variable Interest Entities – an Interpretation of ARB No. 51, changes 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 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.

Keywords: Accounting, FIN 46, Cost of Capital, Off Balance Sheet Financing

JEL Classification: G12, G32, M41, M43, M44