The Impact of Operating Leases and Purchase Obligations on Credit Market Prices
Sandro C. Andrade
University of Miami - Department of Finance
University of Miami - School of Business Administration
July 1, 2013
We document that credit spreads are positively related to two types of off-balance sheet contracts: noncancellable operating leases and unconditional purchase obligations. However, while leases and purchase obligations receive the same treatment by the Bankruptcy Code and current financial reporting rules, the credit spread impact per unit of leverage from purchase obligations is substantially less than that from leases. We conjecture that the impact of executory contracts on credit spreads depends on how essential the underlying assets or services are for the functioning of a bankrupt firm as a going concern. Essential contracts are likely to be unconditionally assumed by bankruptcy trustees, thus representing potentially higher post-default losses for holders of unsecured debt. Our findings potentially inform accounting standards that propose recognizing firms' operating lease obligations in financial statements while continuing to require solely footnoted disclosure of purchase obligations.
Number of Pages in PDF File: 51
Keywords: operating leases, purchase obligations, credit spreads, accounting standards
JEL Classification: G12, G18working papers series
Date posted: October 10, 2011 ; Last revised: October 3, 2013
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