Abstract The author was extremely interested to find that Professor Rick Elam had conducted a study analyzing the effect of lease data on the predictability of financial ratios, for bankruptcy prediction. Prediction could be improved by adding to the asset and liability base and the probable effect on earnings when leases are capitalized. Problem firms utilize leasing to a greater extent than non-problem firms, although this relatively greater use may change as the bankruptcy date approaches. Professor Deakin found that failed firms tended to expand quite rapidly several years prior to failure and that the "expansion was financed by increased debt and preferred stock rather than common stock and retained earnings." Elam clearly has made a contribution in his assessment of lease capitalization on ratio predictability. The analysis did not go far enough in its investigation of relative lease usage, the comprehensiveness of ratio inclusion and the sophistication of the statistical technique utilized. Since lease capitalization is now accepted by academicians and practitioners alike, a full understanding of its impact is crucial.
Edward I. Altman (Thu,) studied this question.