Do Lenders Uniformly Capitalize Operating Leases in Debt Covenants?

Abstract

This study investigates whether lenders capitalize operating leases uniformly when defining debt covenants. The purpose is to understand whether operating lease characteristics are correlated with debt covenant choices to make inferences regarding lenders’ demand for lease accounting rules. Using a hand-collected sample of lending agreements from firms that use operating leases extensively, I find a positive association between the probability of lenders capitalizing operating leases into debt covenants and the duration of borrowers’ lease contracts. The results indicate that lenders discriminate among operating leases when designing debt covenants and suggest that operating leases vary in their effect on credit risk.