The impact of tax and financial reporting concerns on lessee firms' lease-type decision: Capital, operating, and synthetic leases

Abstract

This project clarifies previous ambiguity about the role of tax and financial reporting concerns in lessee firms' lease-type decisions. A private data set provided by anonymous lessor firms is used to accurately identify for the first time the lessee's lease-type and its use of related tax deductions. This project also considers for the first time the role of hybrid lease products such as the synthetic lease in managers' ability to balance firms' tax versus financial reporting concerns. Prior research even in the period after synthetic leases were introduced to the market relied on noisy public data that was unable to parse out lease-types and tax deduction use with unambiguous tax versus financial incentives. Contrary to prior studies, consistent strong evidence is provided indicating that lease choice varies with proxies for lessee firms' marginal tax rates (MTR's). Also contrary to previous research, only weak evidence is found for the role of financial reporting concerns as proxied by leverage measures. The strong results on the MTR variable, taken with the weak results on the leverage variable suggest that tax costs are a stronger influence on leasing choice than financial incentives. This general conclusion about the stronger role of tax incentives in comparison to financial reporting incentives is not consistent with the summary findings of previous research. However, these results support widely held expectations by leasing industry experts. This evidence is also consistent with beliefs about the relative efficiency of the financial market to appropriately value disclosed accounting information.