10-30-2024
On August 17, 2010, the Financial Accounting Standards Board (FASB) issued the lease exposure draft, proposing that firms capitalize most operating leases on their balance sheets. Such a monumental change carried profound consequences. Operating leases had long allowed companies to keep financial obligations off their balance sheets, presenting a more favorable picture of financial health.
The proposed new rule, later formalized as ASC 842 in 2016 and adopted in 2019, aimed to end this practice, impacting leverage and key financial ratios critical to investors and creditors. According to The Wall Street Journal, this could add an estimated $2 trillion in liabilities to corporate balance sheets.
In our recent study, “Anticipatory Effects of Accounting Standards: The Lease Exposure Draft” published in Review of Accounting Studies, we examine how the anticipation of these accounting changes affected firms. We find that loan spreads increased for firms with higher operating lease intensity even before ASC 842 was formally implemented. This suggests that lenders were already factoring in the anticipated rise in leverage. This lead to increased borrowing costs for firms that rely heavily on operating leases.
We identify two key channels behind this anticipatory effect. First, perceived default risk: lenders expected that capitalizing operating leases would make firms appear riskier, driving higher borrowing costs. Second, the Hirshleifer effect: lenders faced uncertainty about how the new rule would impact firms' future default risks, prompting them to charge more to compensate for that uncertainty.
Moreover, we find that the anticipation of future lease capitalization has real effects on firms' operational behavior. Companies began reducing their reliance on operating leases and cut back investments well ahead of the official adoption of the new standard ASC 842, reflecting a proactive response to anticipated changes in financial reporting.
Our research highlights the importance of understanding not just the implementation effects of new accounting standards, but also the anticipatory actions they provoke. The findings suggest that the mere announcement of such standards can ripple through financial markets. It can alter firm strategies and cost of debt long before the rules take effect. For policymakers, this underscores the potential unintended consequences of regulatory changes on corporate behavior and financial markets.
Lin Qiu is an Assistant Professor in the Accounting area at Purdue's Mitch Daniels School of Business. Her research examines how disclosure affects the cost of capital in financial markets as well as topics in corporate governance, including the board of directors, executive compensation, and organizational culture.
