Off balance sheet financing (OBF) is either not visible or only partially visible in financial reporting for a number of reasons. It has attracted controversy in the light of its employment in a number of major corporate scandals. Previous investigations dominated by short works and consultancy papers have focused mainly on the financial aspects of OBF. This academic cross-country research on the use of OBF in the UK and US capital markets was undertaken to extend the published analyses to include a legal perspective by studying its legal implications for directors, financial advisers, auditors and financial regulators. The study’s legal focus prompted relying primarily on the doctrinal approach, which was in turn completed by the use of a modified case study in order to help address the how and why issues of the research phenomenon. The study found that OBF instruments are double-edge financial instruments with good and bad consequences. When corporations used OBF for liquidity enhancement or to realise financial savings, they result in positive outcomes. In contrast, when used for aggressive window-dressing or in the manipulation of financial reporting for fraudulent ends, OBF mechanisms generated serious legal liabilities for directors, auditors, and financial advisers in terms of compensation suits or even criminal sanctions. Financial regulators were nonetheless found to be less likely to face legal consequences as a result of current judicial attitudes on the tort of public misfeasance. However, the extensive applications of OBF in conjunction with other forms of creative accounting have resulted in various regulatory responses. On a comparative note, litigation and enforcement actions were found to be relatively more extensive in the US because of the higher incidence of large corporate frauds and the work of regulatory champions especially in New York using deferred prosecution agreements.

The Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities – An Interpretation of ARB No. 51, in January 2003 and revised it in December 2003, with the objective to improve the transparency of financial information. Under FIN 46, companies are required to consolidate variable interest entities (VIEs) on financial statements if they are the primary beneficiaries of the VIEs. This dissertation empirically examines whether the implementation of this new financial reporting guidance affects firms’ accruals quality and investment efficiency. A manually collected sample comprised of firms affected by FIN 46 and firms disclosing no material impact from FIN 46 is used in the empirical analyses.The first part of the dissertation investigates the effects of FIN 46 on accruals quality. By using different accrual quality measures in prior studies, this study found that firms affected by FIN 46 experienced a decrease in accrual quality compared to firms reporting no material impact from FIN 46. Among the firms affected by FIN 46, firms consolidating VIEs were compared with firms terminating or restructuring VIEs. The accruals quality of firms consolidating VIEs was found to be lower than that of firms terminating or restructuring VIEs. These results are consistent in tests using alternative control samples.The second part of this dissertation examines the effects of FIN 46 on investment efficiency. Mixed results were found from using two different proxies used in prior literature. Using the investment-cash flow sensitivity to proxy for investment efficiency, firms affected by FIN 46 experienced a decrease in investment efficiency compared to firms reporting no material impact. It was also found that higher investment-cash flow sensitivity for firms consolidating VIEs during post-FIN 46 periods compared to both the no-impact firms and the matched pair control sample. Contrasting results were found when the deviation from expected investment is used as another proxy for investment efficiency. Empirical analyses show that FIN 46 firms experienced improved investment efficiency measured by the deviation from expected investment after their adoption of FIN 46. This study also provides explanations for the opposite results from the two different proxies.