An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Weili Ge
University Of Washington

Abstract: This paper examines the implications of the off-balance-sheet treatment of operating leases for future earnings and stock returns. The property rights granted by an operating lease contract generate both future benefits (off-balance-sheet capital investment) and future obligations (off-balance-sheet financing liabilities) for the lessee. The change in the off-balance-sheet capital investment can be viewed as a form of growth in operating assets and also a form of off-balance-sheet accruals. By examining the footnote disclosure on operating leases, this paper shows that greater off-balance-sheet operating lease activities lead to lower future earnings. This finding is consistent with diminishing marginal returns associated with increased investment in operating leases. Additional tests show that investors incorrectly estimate the implications of off-balance-sheet lease activities for future earnings. These results indicate that the accrual anomaly extends to off-balance-sheet accruals.

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