Recognition versus disclosure of finance leases: Evidence from Japan

Abstract

This study examines whether credit market participants—bond investors and credit rating agencies—treat recognized and disclosed finance leases differently when assessing firms’ credit risk in Japan. I use firms’ credit risk, measured by bond spreads and credit ratings, to investigate the relations between recognized versus disclosed finance lease obligations and firms’ credit risk following the adoption of Statement No. 13, Accounting Standard for Lease Transactions. For a sample of firms issuing new bonds, I find that, unlike recognized finance leases, disclosed finance leases are not associated with bond spreads. Moreover, the associations between recognized versus disclosed finance leases and bond spreads are substantially different. Conversely, recognized and disclosed finance leases are associated with credit ratings and are processed similarly when credit ratings are determined. Taken together, my results suggest that the sophistication of capital market participants influences their credit risk assessments of recognized versus disclosed finance leases.

Does recognition versus disclosure affect risk relevance? Evidence from finance leases in Japan

“…setting, some prior studies analyze the risk relevance of recognized and disclosed finance lease obligations (Arata, 2013;Kusano, 2017b). For instance, Arata (2013) investigates whether debt investors process disclosed finance lease obligations differently from recognized finance lease obligations using bond spreads.…”

“…13 setting. Furthermore, Kusano (2017b) examines whether credit market participants-bond investors and credit rating agencies-make different risk assessments between recognized and disclosed finance leases. He reports that the associations between recognized versus disclosed finance leases and bond spreads are substantially different but that recognized and disclosed finance leases have the same risk relevance for explaining credit ratings.…”

“…Using Japanese lease accounting as the research setting can prevent the joint hypothesis problem. In this respect, Arata (2013) and Kusano (2017b) provide useful evidence on recognition versus disclosure of lease arrangements. However, they fail to investigate why disclosed finance leases are treated differently from recognized finance leases.…”

“…Employing this unique setting, few prior studies examine the associations between recognized versus disclosed finance leases and firms' credit risk (Arata, 2013;Kusano, 2017b). For instance, Arata (2013) reports that debt investors process disclosed and recognized finance leases differently when assessing firms' credit risk.…”

“…Even though capital market participants incorporate disclosed leases into their decision making, it is uncertain whether they process disclosed and recognized leases similarly. In fact, prior studies examine the associations between recognized versus disclosed leases and firms' risk but provide mixed evidence on these associations (Arata, 2013;Bratten et al, 2013;Dhaliwal et al, 2011;Kusano, 2017b;Sengupta and Wang, 2011). Using the standard deviation of daily stock returns as the measure of firms' equity risk, this study analyzes whether disclosed finance leases are associated with firms' equity risk and whether the associations between recognized versus disclosed finance leases and firms' equity risk are substantially different.…”