Market Reaction to the Introduction of K-IFRS 1116

Abstract

This study examines the Korean stock market reaction to the introduction of K-IFRS 1116 (IFRS 16 equivalent) which effectively eliminates the operating lease and requires all lease contracts to be considered as finance leases. An event study is conducted whereby abnormal returns around the standard announcement are examined in conjunction with selected firm characteristics. We find that the level of operating lease usage and extent of financial constraint are negatively associated with the market reaction following the announcement of the K-IFRS 1116. However, an interaction effect between the two variables is found to be absent. Additionally, we find that this negative market reaction to financial constraint is mostly led by severely financially unhealthy firms that disregard operating lease usage. We interpret the results of operating lease usage and financial constraint to demonstrate the effects of the deprival of off-balance-sheet benefits and an expectation adjustment in investors' perceived future cash flow prospects, respectively. These findings are consistent with the impact of capitalizing leases on financial ratios and risk assessment of affected companies. We contribute to the literature and practice by providing evidence on the market participants' perception of the implementation of revised lease accounting standards.