Did the Recognition of Operating Leases Cause a Decline in Equity Valuations?
51 Pages Posted: 15 Jan 2020 Last revised: 1 Jun 2020
Date Written: May 30, 2020
We examine whether investors react to a significant change in financial statements absent a significant change in underlying economics. Beginning in 2019, ASC 842 requires the recognition of operating leases, which were previously only disclosed in the footnotes. This change in accounting standard has no effect on firms’ economics but results in firms with significant operating leases recognizing a considerable increase in debt. We find that firms with significant operating leases, on average, earn negative returns around the initial recognition of their operating leases. For example, firms above the 95th percentile of operating lease intensity experience a mean abnormal return of -5.50% during the two weeks around their first quarter 2019 earnings announcements. Our results suggest that the higher information processing costs inherent in disclosed versus recognized information can lead to mispricing, even in the case of a common and well-known accounting distortion.
Keywords: fundamental analysis; market efficiency; leases; information processing costs; disclosure versus recognition; financial statement analysis; ASC 842
JEL Classification: G10, G12, G14, M40, M41, M48
Suggested Citation: Suggested Citation