What It Is

Earmarking refers to the act of setting aside funds for special purposes or specific projects. Companies and governments earmark funds frequently.

How It Works

For example, let's assume Company XYZ issues $100 million of bonds and that $20 million of it is earmarked for the construction of a new factory. This means that Company XYZ intends to set aside $20 million of the proceeds (perhaps even in a separate bank account) for the factory capital expenditures.

In a bankruptcy situation, the "earmarking doctrine" allows borrowers -- just before filing for bankruptcy -- to make payments to creditors with funds given to the borrower by another creditor. These funds are earmarked in that they are dedicated to paying off a particular creditor and thus aren't technically part of the borrower's property. The earmarking doctrine requires these types of transfers to have a written agreement from all three parties, and the borrower cannot have control over the funds.

Why It Matters

In the corporate world, earmarking is essentially a way of organizing and allocating money.

In government, however, earmarking also comes with a good deal of controversy because the earmark language is often embedded in unrelated legislation and approved or rejected for reasons other than the merits (or lack thereof) of the earmarks.

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Source: Investing Answers