An empirical investigation into the association between accounting risk measures adjusted for capitalization of lease commitments and the market risk measure

Since a function of external financial reporting is to aid investors in making investment decisions, alternative methods of reporting accounting information can be evaluated in terms of their impact upon these decisions. In modern portfolio theory, it is held that the market risk measure (systematic risk) is the appropriate measure of a security's or of a portfolio of securities' riskiness under a market equilibrium condition. Therefore, it can be asserted that an accounting method that improves investors' assessments or predictions of the future level of the market risk measure has increased relevance in making investment decisions.

The primary purpose of this study is to investigate the association between a set of accounting risk measures adjusted for lease capitalization and the market risk measure. Two samples of lessee firms were selected from the population of New York Stock Exchange companies. Sample 1 is madeup of 58 firms who are members of three industries knownto use leasing extensively whereas Sample 2 consists of l06 firms representing a subpopulation of all lessees. Each sample is further divided into two sub-samples with an equal number of firms. Based on financial data for 1973 through 1976 obtained from COMPuSTAT files and annual reports, three sets of six accounting risk measures were computed for each firm. Set 1 accounting risk measures are based on reported financial statement data. Set 2 accounting risk measures are Set 1 accounting risk measures adjusted for the effects of capitalizing iv

financing leases (as defined by the Securities and Exchange Commission) while Set 3 accounting risk measures reflect the effects of capitalizing all noncancelable leases. Within each sub-sample, the Spearman rank correlation coefficient between each accounting risk measure and the market risk measure (estimated through the market model and stock price data from the CRSp file) was calculated. . Using Fisher's z-transformation test procedure, intra-sample comparisons were then made among the correlation coefficients to determine whether one set of accounting risk measures are more closely associated with the market risk measure than another set. Results indicate no significant differences in the association between each set of accounting risk measures and the market risk measure. Therefore, it is concluded that lease capitalization as a method of reporting lease information was not more relevant in making investment decisions than alternative methods of presentation.

As a secondary objective, this study examines the impact of the disclosure of lease information in compliance with Accounting Series Release No. 147 and Accounting Principles Board Opinion No. 3l upon the level of the market risk measure. The Student-t test was employed in testing a hypothesis that the average level of the market risk measure during a post-disclosure period (January, 1973 through December, 1977) was significantly higher than that during a pre-disclosure period (January, 1968 through December, 1972). The evidence obtained leads to a rejection of the hypothesis. Thus, the disclosure of lease information as required by the two pronouncements does not appear to have an adverse economic impact upon lessees in terms of their cost of equity capital.

Based on a contention that the requirements of Statement of Financial Accounting Standards No. 13 are essentially the same as those required by ASR 147 and APB Opinion 3l, the findings of this study should be of particular interest to the accounting standard-setting bodies in their continuing efforts to improve accounting and disclosure standards for leasing transactions.