No. 258: The Determinants and Consequences of Non-Compliance Detected in Operating Lease Disclosures

Using a novel detection mechanism, I study non-compliance with disclosure requirements for operating lease commitments (OLCs) under IAS 17 in Italy. I first analyze the determinants of firms’ non-compliance and then assess whether the revelation of their previously undisclosed OLCs has consequences for their cost of equity. In the determinants analysis, I predict and find that such non-compliance is positively and significantly associated with pre-existing financial leverage. I also find some evidence of an association with having a Big 4 auditor. In the consequences study, I document a statistically and economically significant decline in non-compliant firms’ cost of equity relative to control firms after the revelation. This result is consistent with investors initially overestimating operating leases and the associated leverage risk when using alternative estimation methods in the absence of OLC disclosures.