Off-Balance Sheet

DOI: 10.1111/j.1475-679x.2005.00170.x Journal of Accounting Research Vol. 43 No. 2 May 2005 Printed in U.S.A.

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

L I L L I A N F. M I L L S ∗ A N D K AY E J . N E W B E R R Y ∗ Received 5 January 2004; accepted 27 November 2004

ABSTRACT

We match large U.S. corporations’ tax returns during 1989–2001 to their financial statements to construct a firm-level proxy of firms’ use of off-balance sheet and hybrid debt financing. We find that firms with less favorable priorperiod Standard & Poor’s (S&P) bond ratings or higher leverage ratios in comparison to their industry report greater amounts of interest expense on their tax returns than to investors and creditors on their financial statements. These between-firm results are consistent with credit-constrained firms using more structured financing arrangements. Our within-firm tests also suggest that firms use more structured financing arrangements when they enter into contractual loan agreements that provide incentives to manage debt ratings.

∗ University of Arizona. We appreciate helpful comments from Phil Berger (editor), Ed Maydew (discussant), an anonymous referee, Ashiq Ali, Anne Beatty, Larry Brown, Julie Collins, Bill Gentry, Bill Maxwell, Richard Sansing, Stacie Kelley, George Plesko, William Schwartz, and workshop participants at the University of Arizona, Georgia State University, University of North Carolina 2004 Tax Symposium, Journal of Accounting Research 2004 conference, and the American Accounting Association 2004 annual meeting. The Internal Revenue Service (IRS) provided confidential tax information to the authors pursuant to provisions of the Internal Revenue Code that allow disclosure of information to a contractor to the extent necessary to perform a research contract for the IRS. None of the confidential tax information received from the IRS is disclosed in this treatise. Statistical aggregates were used...