ASC 842 and the Investment, Financing, and Accounting Decisions of EBITDA-Focused Firms
Open AccessThis study examines the effect of ASC 842 on the leasing and long-term asset purchase decisions of firms that use EBITDA in executive incentive plans. ASC 842 requires firms to capitalize operating leases, leading to higher leverage and asset base. While the impact on net income over the course of the lease is comparable for operating and finance leases, the impact on EBITDA is materially different. Amortization and interest expenses resulting from finance leases are excluded from EBITDA while operating lease expenses are reported in EBITDA. Consequently, I hypothesize and find that EBITDA-focused firms’ finance lease liabilities increased after the issuance of ASC 842 relative to non-EBITDA-focused firms. The increase is smaller for EBITDA-focused firms that also apply balance sheet-based or stock price targets in their managerial incentive plans. I also find comparable decreases in long term asset purchases for EBITDA reliant and non-EBITDA reliant firms post ASC 842, even though EBITDA reliant firms are overleveraged relative to their peers. This suggests that the exclusion of interest expenses from EBITDA prompts EBITDA-focused firms to set higher borrowing cost thresholds post ASC 842 relative to non-EBITDA-reliant firms. Finally, while the profitability of non-EBITDA-focused firms increased following the issuance of ASC 842, I do not observe an increase in the profitability of EBITDA-focused firms. Overall, the paper documents an unintended consequence of ASC 842 and highlights the adverse effects of the use of EBITDA as a performance metric.
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AlMatouq_gwu_0075A_15953.pdf | 2022-04-25 | Open Access |
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