Creating Value from Financial Engineering  663
paid only by their owners. Therefore, in the United States, placing hotels in 
partnerships and REITs eliminates an entire layer of taxation. With owner-
ship and operations separated in this manner, total income taxes are lower, so 
investors in the ownership and operating companies are better off as a group 
because their aggregate cash flows are higher.
However, these deals are very complex, because they need to ensure that 
the interests of the owner and management company are aligned. For exam-
ple, the deals need to define in advance how the REITs and the hotel compa-
nies will make decisions about renovating the hotels, terminating the leases, 
and other situations where the interests of both parties could conflict. Un-
fortunately, such potential conflicts are sometimes overlooked or are simply 
too complex to cover in advance. The owners of Mervyn’s (a clothing retail 
chain in the United States) attempted something similar in 2004 but failed to 
align the interests of the real estate company and the operating company.50 
While Mervyn’s had plenty of other problems, this structure exacerbated the 
difficulty of improving the company’s performance. Mervyn’s filed for bank-
ruptcy in 2008. All its stores were closed and its assets liquidated in 2009.
In other cases, off-balance-sheet financing aims primarily at enabling a 
company to attract debt funding on terms that would have been impossible to 
realize for traditional forms of debt. A well-known example is the large-scale 
securitization of customer receivables undertaken by several auto companies. 
These companies sold large sums of their receivables to fully owned but le-
gally separate entities.51 Because the receivables represented relatively sound 
collateral, these entities had better credit ratings and credit terms than their 
parent companies. This effectively enabled the companies to tap large sums 
of debt for investments that otherwise would have been difficult to obtain at 
similar terms—although one can question whether the investments they made 
resulted in any value creation, as the securitization structures fell apart in the 
2008 credit crisis.
Other successful examples include the use of project financing for building 
and running large infrastructure projects such as gas pipelines, toll bridges, 
and tunnels. Companies (or sometimes governments) in emerging markets 
and with low credit ratings may have difficulty attracting large sums of debt. 
But they can use project financing to raise cash for the initial investments; once 
the infrastructure asset is operational, the interest and principal on the debt 
are paid to the lender directly from the cash flows from the asset’s revenues. In 
this way, the debt service is assured, even if the company itself goes bankrupt.
Some managers find off-balance-sheet financing more attractive because 
it reduces the amount of assets shown on the balance sheet and increases the 
50 Emily Thornton, “What Have You Done to My Company?” BusinessWeek, December 8, 2008, pp. 
40–44.
51 These represent examples of a so-called special-purpose entity, or—as referred to under U.S. Gener-
ally Accepted Accounting Principles—a variable-interest entity.