Financial Reporting Quality, Private Information, Monitoring, and the Lease-versus-Buy Decision

Abstract

We would like to thank Wayne Thomas and two anonymous reviewers for many helpful suggestions that have resulted in substantial improvements to the paper.Electronic copy available at: http://ssrn.com/abstract=1499306 1 ABSTRACT: A flourishing research stream examining how accounting quality affects asset purchases ignores off-balance sheet leasing. This research concludes that low accounting quality limits firms" access to capital for investments. Our finding that low accounting quality firms lease more of their assets has important implications for interpreting this research. Although low accounting quality firms may purchase fewer assets, our results suggest that these firms may substitute leased assets for purchased assets. To verify that leasing does not merely reflect these firms" desire for off-balance sheet accounting but instead substitutes for accounting quality when addressing agency problems, we investigate how banks' private information and monitoring affect the relation between accounting quality and leasing. We find a lower association between accounting quality and leasing when banks" have higher monitoring incentives and when loans contain capital expenditure provisions. The mitigation of the negative relation between accounting quality and leasing by other information asymmetry and agency cost reducing mechanisms suggests that this association reflects the role of accounting quality in reducing information problems. These findings also document cross-sectional variation in accounting quality"s affect on leasing. Our paper suggests that ignoring the substitution between leasing and asset purchases affects the inferences from prior research.

Who monitors opaque borrowers? Debt specialisation, institutional ownership, and information opacity

“…Beatty et al . () further propose that the legal protection of lessors, including the immediate repossession of lease property following the breach of contract, make lease financing largely available to firms with poor financial information quality.…”

The Value Relevance of Operating Lease Liabilities: Economic Effects of IFRS 16

“…Moreover, Beatty et al. () document that firms with information asymmetries due to poor accounting quality are more likely to engage in operating lease transactions – which in essence amounts to off‐balance financing. To the extent that other parties do not properly assess the firm's financial position, the firm might benefit from such information remaining private.…”

The real effects of corporate fraud: evidence from class action lawsuits

“…Beatty et al . () find that firms with poor accounting quality are more likely to lease than purchase assets, as lessors' superior control rights allow them to provide capital to financially constrained firms with low‐quality accounting. In addition to financing, several recent studies suggest that higher quality accounting information should increase firm investment efficiency by reducing information asymmetry between managers and outside suppliers of capital.…”

“…Beatty et al . () show that private information and bank monitoring can reduce the importance of accounting quality on investment efficiency. We contribute to this line of research by examining the effects of an extreme case of poor information quality, fraud revelation, on corporate financing and investment.…”