THE ASSOCIATION OF SFAS 166/167 AND COST OF EQUITY CAPITAL: EVIDENCE FROM BANKS

Abstract

We examine whether SFAS 166/167, which ended exclusion of qualifying special purpose entities (QSPEs) from consolidation, impacted the cost of equity capital for a sample of banks. This exclusion previously allowed banks to avoid consolidating many, risky asset securitization transactions. These transactions were prevalent during and after the global financial crisis (GFC). We compare changes in the cost of equity capital for a sample of banks that consolidated SPEs after implementation of SFAS 166/167, to a control group of banks that reported no material impact of SFAS 166/167. We find the cost of equity capital increased significantly more for the banks consolidating previously unconsolidated SPE’s, than for the banks that were relatively unaffected by the rule change. In particular, we find that banks with greater reductions to their reported Tier-1 capital ratios as a result of consolidation are associated with significantly greater cost of equity capital in the post-SFAS166/167 period.