Off-Balance Sheet Financing

Off-Balance Sheet Financing

Off-balance sheet financing has been used for decades. When a company does not list a liability on its balance sheet, this is considered off-balance sheet financing. Companies use off-balance sheet financing for several reasons, but the main objective that the companies hope to accomplish is to make their financial position seem better than it actually is (Feldman). Over the years, companies have been able to continuously use off-balance sheet financing due to the lack of rules forbidding these types of procedures. Although off-balance sheet financing is considered legal, it is not very ethical. It seems that there has been little or no effort being put forth by the appropriate rule-making bodies to stop or at least slow down the use of off-balance sheet financing. It also seem as though they are not making any plans to establish rules for the use of off-balance sheet financing in the future.

Why Does Off-Balance Sheet Financing Exist? Off-balance sheet financing exists because of the fact that companies do not always want their real financial position to be made public. If the companies’ investors, customers, bankers, etc. knew about their financial state, they could possibly change their views of the company. For example, if the company has a poor financial state, the investors could choose not to invest in the company anymore, the customers could choose not to buy products from the company anymore, and the bankers could choose to no longer finance the company. Some examples of off-balance sheet financing are the use of Special Purpose Entities (SPEs) and the use of Special Investment Vehicles (SIVs) (Feldman 1). These are used to decrease the visibility of a companies’ finances, basically deceiving the public (Schwarcz 376) In order for the company to stop any of the previous listed situations from occurring, they try to keep the amount of debt that they owe hidden from the companies stakeholders. The company wants to keep their debt-to- equity ratio as low as possible, just as much as the people involved with the company want the debt-to-equity ratio to be low. Companies are able to keep part of the amount of debt that they owe hidden by simply keeping it off of the balance sheet (Ittelson 211). By not revealing the whole amount of debt that they owe, they are allowing their stock prices to remain at a higher level and allowing their poor performance to be kept from the public. By not revealing all of their debt, this gives a false sense of financial stability to stakeholders. (Weissman and Donahue 15-16). Most off-balance sheet financing is done by companies whose internal controls are not very strong and whose management team probably has an untrustworthy character and is under a lot of stress to perform at a high level. Although it is fortunate for companies that off-balance