Reporting and Non-Reporting Incentives in Leasing

Abstract

This study sheds light on the extent to which the use of operating leases depends on reporting incentives, such as understating liabilities, and non-reporting incentives that partly arise from the overlap between accounting, bankruptcy, and tax laws, such as increasing financing capacity and flexibility. We provide evidence that expanding financing capacity, accommodating volatile operations, and maximizing the present value of tax deductions are all important drivers of leasing decisions. Our findings suggest that capital markets and contracting based reporting incentives have little influence on operating lease use. In particular, we find weak evidence that firms increase operating leases in advance of issuing equity and no evidence that firms use operating leases to window-dress in advance of issuing debt, to avoid debt covenant violations, for compensation purposes, or to paint a better picture on an ongoing basis. These findings are consistent with reporting incentives playing a second-order role in leasing decisions.

Keywords: Bankruptcy, tax, operating flexibility, reporting incentives, airlines, lease accounting

JEL Classification: G32; G33; K34; M41