Lease Accounting Rule Changes and Debt Covenant Characteristics

• In Event: Financial Reporting

Abstract

The purpose of this study is to draw inferences about lenders’ demand for lease accounting rules in light of proposed lease accounting standard changes. I provide evidence that lenders adjust contracting behavior following borrowers’ adoption of SFAS 13 accounting standards and allow balance-sheet measures of capital lease liability to affect debt covenant calculations. I find that lenders are significantly less likely to inhibit leasing activity via lease restrictions after SFAS 13 adoption. When I examine post-adoption years, I document an increasing trend of rental expense to capital leases. Consistent with the argument that lease transactions evolved to fit bright-line thresholds, I document that lenders are significantly more likely to modify debt covenants to capitalize operating leases across time in the post-adoption period. These results suggest that lenders view leases as affecting debt value and that lenders mitigate lease-associated risks using debt covenants apart from price protection. Further, the results suggest that lenders adapt their contracting behavior to changing financial reporting incentives of borrowers relating to the bright-line thresholds of SFAS 13 accounting standards.

Author

• Bryan Graden, Illinois State University