Off-Balance-Sheet Activities, Earnings Persistence and Stock Prices: Evidence from Operating Leases

58 Pages Posted: 1 Oct 2005

See all articles by Weili Ge

Weili Ge

University of Washington - Michael G. Foster School of Business

Date Written: November 22, 2006

Abstract

This paper examines the implications of the off-balance-sheet treatment of operating leases for future earnings and stock returns. The property rights granted by an operating lease contract generate both future benefits (off-balance-sheet capital investment) and future obligations (off-balance-sheet financing liabilities) for the lessee. The change in the off-balance-sheet capital investment can be viewed as a form of growth in net operating assets and also a form of off-balance-sheet accruals. By examining the footnote disclosure on operating leases, this paper shows that, after controlling for current earnings, greater off-balance-sheet operating lease activities lead to lower future earnings. This finding is consistent with diminishing marginal returns to investment in operating lease activities. Additional tests show that investors incorrectly estimate the implications of off-balance-sheet lease activities for future earnings. A long-short investment strategy that exploits this misestimation generates significant future abnormal stock returns. These results suggest that the accrual anomaly documented in prior research extends to off-balance-sheet lease accruals.

Keywords: Operating lease, Earnings persistence, Off-balance-sheet financing, Capital investment

JEL Classification: G10, M4

Suggested Citation

Ge, Weili, Off-Balance-Sheet Activities, Earnings Persistence and Stock Prices: Evidence from Operating Leases (November 22, 2006). AAA 2006 Financial Accounting and Reporting Section (FARS) Meeting Paper. Available at SSRN: https://ssrn.com/abstract=816044 or http://dx.doi.org/10.2139/ssrn.816044

Weili Ge (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

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