Financial Reporting Quality, Private Information, Monitoring and the Lease-Versus-Buy Decision

Abstract

A flourishing research stream examining how accounting quality affects asset purchases ignores off-balance sheet leasing. This research concludes that low accounting quality limits firms’ access to capital for investments. Our finding that low accounting quality firms lease more of their assets has important implications for interpreting this research. Although low accounting quality firms may purchase fewer assets, our results suggest that these firms may substitute leased assets for purchased assets. To verify that leasing does not merely reflect these firms’ desire for off-balance sheet accounting but instead substitutes for accounting quality when addressing agency problems, we investigate how banks' private information and monitoring affect the relation between accounting quality and leasing. We find a lower association between accounting quality and leasing when banks’ have higher monitoring incentives and when loans contain capital expenditure provisions. The mitigation of the negative relation between accounting quality and leasing by other information asymmetry and agency cost reducing mechanisms suggests that this association reflects the role of accounting quality in reducing information problems. These findings also document cross-sectional variation in accounting quality’s affect on leasing. Our paper suggests that ignoring the substitution between leasing and asset purchases affects the inferences from prior research.

Keywords: financial reporting quality; private information; monitoring; lease-versus-buy