On Tuesday, July 28th, 4pm ET, Cathy Shakespeare will lead a discussion on securitization.  Cathy will start by giving us a gentle introduction to this complex commercial arrangement, and then use recent research to indicate directions for future work.  To get insights into one of the most central issues in securitization you might start with this paper with co-authors Wayne Landsman and Ken Peasnell:

Are Asset Securitizations Sales or Loans?

Abstract: This study addresses whether asset securitizations are really asset sales or a form of secured borrowing, by estimating cross-sectional equity valuation regressions to assess whether the stock market treats securitized assets and liabilities held by a special purpose entity (SPE) as assets and liabilities of the sponsor-originator (S-O). Overall, we find that the market views the SPE assets and liabilities as belonging to the S-O, i.e., the risk and rewards of ownership of the transferred assets reside with the S-O and not the SPE. Results from a boot-strapping simulation that controls for scale by randomly assigning SPE assets and liabilities from one S-O to another provide evidence that scale bias is an unlikely explanation for finding the market views SPE assets and liabilities as belonging to the S-O. Findings from specifications in which we permit coefficients to differ for S-O firms with high and low relative levels of retained interest indicate that whereas the market views asset securitizations by low retained interest S-O firms as sales, i.e., risk transfer has taken place, it views asset securitizations by high retained interest S-O firms as secured borrowings, i.e., risk transfer is incomplete. We also show that although the market views securitizations by regulated and unregulated S-Os as secured borrowing, there is suggestive evidence that regulated firms have greater incentives to use securitizations to achieve off-balance sheet financing.

To understand how managers use securitization to achieve earnings goals, take a look at this recent paper Cathy wrote with Patty Dechow and Linda Myers:

Fair Value Accounting and Gains from Asset Securitizations: A Convenient Earnings Management Tool with Compensation Side-Benefits

ABSTRACT:  We provide evidence that managers use the discretion afforded by fair-value accounting rules to manage the size of reported securitization gains. We show that the ambiguity allowed in discount rate choice is one way that managers can influence these gains. We investigate whether CEO compensation is less sensitive to securitization gains than to other earnings components in the presence of proxies for how independent (outsiders, females, fewer CEO-selected directors) and informed (financial expertise) directors are. We find weak evidence of less earnings management in firms with more independent boards, but find no evidence that our director characteristics influence CEO pay-sensitivity to the gains. Thus, boards do not appear to intervene and adjust compensation for implementation problems related to fair-value accounting rules for securitizations.

For a broader overview, U of M’s public relations department has done a nice job of summarizing some of the key issues Cathy has been looking at lately.

We will update this post shortly with some more readings, since I haven’t even mentioned FAS 166.