A New Lease on Secured Debt

Abstract

Firms make extensive use of operating leases, but unlike other types of debt, their balance sheet value is set by the firm. Using novel information on operating leases from the recently implemented Accounting Standard Update 842, we examine firm behavior in recognizing the value of these leases. Specifically, we focus on the disclosed discount rate that each firm uses to value its lease portfolio. Although the cost of operating lease debt should, in principle, mirror the firm's cost of non-lease secured debt, we find that one-in-five firms disclose lease discount rates that are much higher than an outsider of the firm would expect. Notably, these high discount rates often reflect the firm's cost of unsecured debt rather than the firm's cost of collateralized borrowing. These firms tend to have poor information quality and financial health, and typically operate in competitive product markets. As a result of higher-than-expected discount rates, these firms underreport lease and debt ratios by about 15%. We also use the more granular disclosures associated with ASC 842 to shed new light on other dimensions of a firm's operating lease portfolio, such as the average life of a firm's operating leases, the firm's propensity to take out leases with embedded options, and connect pre-ASC 842 to post-ASC 842 balance sheet values.

Keywords: ASC 842, Capital Structure, Discount Rate, Operating Lease, Secured Debt

JEL Classification: G00, G30, G31, G32, M40, M41