Firms can finance themselves on- or off-balance sheet. Off-balance sheet financing involves transferring assets to "special purpose vehicles" (SPVs), following accounting and regulatory rules that circumscribe relations between the sponsoring firm and the SPVs. SPVs are carefully designed to avoid bankruptcy. If the firm's bankruptcy costs are high, off-balance sheet financing can be advantageous, especially for sponsoring firms that are risky. In a repeated SPV game, firms can "commit" to subsidize or "bail out" their SPVs when the SPV would otherwise not honor its debt commitments. Investors in SPVs know that, despite legal and accounting restrictions to the contrary, SPV sponsors can bail out their SPVs if there is the need. We find evidence consistent with these predictions using data on credit card securitizations.
*Published: This paper was subsequently published as Special Purpose Vehicles and Securitization, Gary B. Gorton, Nicholas S. Souleles, in NBER book The Risks of Financial Institutions (2006)
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