U.S. GAAP permits firms to offset a significant amount of financial assets and liabilities with the same counterparty, thereby keeping the offsetting financial instruments off the balance sheet. Currently, the offsetting standards represent the single largest difference in balance sheet presentation between U.S. GAAP and IFRS for large financial institutions (FASB 2011). The debate on whether the FASB should allow firms to offset financial instruments has drawn considerable attention from regulators and investors. The focus of this debate is on whether the offsetting financial instruments increase a firm’s credit risk. I measure credit risk using credit default swap spreads and find that offsetting financial instruments are positively associated with a firm’s credit risk. This relation is stronger for firms with higher asset opacity and after the 2011 FASB’s proposal to tighten offsetting standards. In addition, I do not find that recognition versus disclosure significantly affects how debt investors use offsetting information in evaluating a firm’s credit risk.
Read
