Equity Value Implications of Lease Accounting

Abstract

SYNOPSIS: The literature exhibits a long tradition of attention to the financial statement effects of accounting for operating leases. For the most part, that attention has focused on what are commonly viewed as errors in operating assets, deferred tax liabilities, debt, stockholders’ equity, and net income that, if not properly corrected, can lead to errors in financial statement analysis. There has been, at least, an implied effect of such financial statement analysis errors on estimated equity value. What has been lacking is a discussion of the precise nature of how the errors may, or may not, translate into errors in estimating equity value. We bring clarity to this matter through an example in which a nai¨ve reliance on financial statements unadjusted for the errors in accounting for operating leases has no effect on equity value estimated with three popular equity valuation models. We then discuss prior empirical evidence suggesting that the critical aspect of the example, namely the cost of equity capital is exogenously determined, is expected to be present in many practical applications. In short, lease accounting is often not a matter of consequence in the context of estimating equity value.