The economic implications of the earnings impact from lease capitalization

We observe a substantial earnings impact from capitalizing the operating leases for firms on Compustat over 1996-2010. This earnings impact is derived from the disclosed lease information and is similar to the earnings difference that arises from applying the accelerated versus the straight-line model, two alternative models proposed by the Financial Accounting Standards Board and the International Accounting Standards Board (the Boards) in 2013 to account for lease expense for lessees. Our focus is on the economic implications of this earnings impact. Applying a one-year cash flow prediction model, we observe a significant relationship between the negative impact and future operating cash flows. Using a return-earnings model, we find that both negative and positive impacts possess an incremental explanatory power for contemporaneous stock returns beyond reported earnings. Our findings provide timely empirical evidence for the Boards to evaluate two alternative models for lessees' expenses as they are in the midst of redeliberations of accounting for leases.