Real Effects of Lease Accounting

Abstract

This study investigates the valuation and real effects of off-balance-sheet versus capitalization accounting for operating leases. We consider a firm that combines two types of investments to produce short-term and long-term returns. One type of investments (leases) requires periodic expenditures and the other (organization capital) requires an upfront expenditure. We show how the informational difference between the two accounting regimes induces different capital market valuations and different corporate investment decisions. The corporate investment efficiency in an accounting regime hinges on three parameters: persistence of short-term investment return, ratio of productivity of lease investment to productivity of organization capital, and discount rate used to measure lease investment. We find that the off-balance-sheet accounting induces a higher investment efficiency for high values of those parameters whereas the capitalization accounting induces a higher investment efficiency for low values. Our result implies that capitalizing all the operating leases may be detrimental to corporate value creation.

Keywords: Operating leases; Off-balance-sheet; Capitalization; Investment efficiency.

JEL Classification: M41, M48, G18, G38