Did the Recognition of Operating Leases Cause a Decline in Equity Valuations?

Abstract

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 95 th 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.

The Effect of The Recent IFRS 16 on Major Financial Statements’ Ratios

“…With regard to the debt ratio (= total liabilities / total assets), although both liabilities and assets would increase in the same amount, if the debt ratio previously was lower than 1 (which is commonly the case, unless the company has negative equity), the ratio will have to increase. Milian & Lee [2], using preliminary quarterly results from the 2019 financial year, found that the increase in leverage for companies with a high intensity of operating leases can decrease…”