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 (Example):
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.