Lease Capitalization, Financial Agreements and EBITDA
Mulford, Charles W.
Singh, Vipul Pratap
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EBITDA, earnings before interest, taxes, depreciation and amortization, is used by many firms as a measure of performance in financial covenants and incentive compensation agreements. In 2009, when the FASB, in conjunction with the IASB, likely begins requiring firms to report virtually all leases as capital leases, we expect calculated measures of EBITDA to increase. As a result, firms may find unexpected slack in financial covenants and increases in incentive compensation that are unrelated to real improvements in performance. In anticipation of the change in accounting for leases, companies will want to revise contracts that employ EBITDA to ensure that unanticipated consequences are avoided. This research report examines the effects of lease capitalization on EBITDA in cases where it is employed in financial agreements. Our focus is on companies noted to employ EBITDA in financial covenants or incentive compensation agreements with significant exposure to operating leases. For a sample of 25 companies we recalculated EBITDA, treating operating leases as though they were capital-lease commitments. For some firms, we found significant increases in EBITDA, with a sample-wide median increase of 7.7%