This paper studies the financing role of leasing and secured lending. We argue that the benefit of leasing is that repossession of a leased asset is easier than foreclosure on the collateral of a secured loan, which implies that leasing has higher debt capacity than secured lending. However, leasing involves agency costs due to the separation of ownership and control. More financially constrained firms value the additional debt capacity more and hence lease more of their capital than less constrained firms. We provide empirical evidence consistent with this prediction. Our theory is consistent with the explanation of leasing by practitioners, namely that leasing "preserves capital," which the academic literature considers a fallacy.
leasing, secured debt, collateral, repossession, debt capacity, capital structure
This paper studies the role of leasing of productive assets. When capital is
leased (or rented), it is more easily repossessed and hence leasing has higher
debt capacity and relaxes financing constraints. However, leasing gives rise to
an agency problem with regard to the care with which the leased asset is used or
maintained. We show that this implies that more credit constrained firms lease
capital, while less credit constrained firms buy capital. Our theory is consistent
with the explanation of leasing provided by leasing firms, namely that leasing
â€œpreserves capital,â€ which is generally considered a fallacy in the academic
literature. We provide empirical evidence that small and credit constrained
firms lease a considerably larger fraction of their capital than larger and less
leasing, credit constraints, investment, small firms
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