The relation between voluntary disclosure and financial reporting: Evidence from synthetic leases

Managers must often trade off cash flow objectives with concerns about financial reporting when they structure economic activities. I examine whether managers consider voluntary disclosure, combined with the structuring decision, to alter this tradeoff by enhancing the transparency or maintaining the opacity inherent in mandated reporting. Synthetic leases provide an appealing setting to test the role of voluntary disclosure because they can be undertaken for cash flow and/or opacity (i.e., for off-balance sheet reporting) reasons. Firms in my sample differ in their choice of financing for fixed assets (via a synthetic lease or not) and, contingent upon using a synthetic lease, their use of voluntary disclosure. When managers have incentives to defer cash outflows due to high opportunity costs of cash, I find they choose synthetic leases and provide informative disclosure to communicate the contract's advantages. Alternatively, when managers have incentives to maintain opacity, I find that while they still choose synthetic leases, they provide uninformative disclosure. Alternative tests of changes in financing and disclosure choice around FIN 46 adoption corroborate these findings. The likelihood of consolidation increases given the use of synthetic leases with informative disclosure, consistent with cash flow incentives leading managers to retain the contract (and cash flows) and maintain transparency. Overall, the results are consistent with the hypothesis that managers factor voluntary disclosure into the financing decision to either offset or maintain uninformative reporting.