Managing the Balance Sheet with Operating Leases
Kimberly Rodgers Cornaggia American University – Kogod School of Business
Laurel Franzen Loyola Marymount University
Timothy T. Simin Pennsylvania State University
July 19, 2012
We test whether firms use the off balance sheet (OBS) treatment of operating leases in order to strengthen their balance sheets. We find that firms’ lease versus buy decision has changed over time. Time series evidence suggests that firms and industries not expected to have traditional economic benefits of leasing are increasingly financing with operating leases. We infer that such firms use operating leases to expand OBS debt capacity and we explore their incentives to report conservative balance sheets. We find that (1) OBS leasing allows firms to better manage debt covenants limiting debt or capital expenditures (2) unexplained OBS leasing is diminished by scrutiny of institutional investors and (3) firms investigated by the SEC or DOJ for financial misrepresentation exhibit high levels of unexplained operating leases.