Lease Financing and Corporate Governance

Abstract

Lease financing is a well-recognized mechanism for reducing the agency costs of debt. This study examines whether firms that attempt to control the agency costs of equity through strong governance structures, including Chief Executive Officer compensation alignment and board structure, are more likely to use an agency cost reducing debt structure, such as leasing. For a sample of large firms, we find that firms who use more incentive compensation and have more outside directors also tend to use more lease financing, suggesting these agency cost reducing measures are complements. Copyright (c) 2008, The Eastern Finance Association.

Is executive compensation a substitute governance mechanism to debt financing and leasing?

“…As reported in Columns 1, 2 and 3 of Table 4, the regression specifications produce consistent results that suggest market measure of finance leases (FLRM) is negatively related to CEO equity incentives. The study of Robicheaux, Fu and Ligon (2008) presents similar results. The results for operating leases are reported in Columns 4, 5 and 6.…”

“…The substitutability of executive compensation and debt/leases as corporate governance mechanisms in mitigating the agency cost of equity has not been documented in prior compensation and capital structure studies [e.g., (Ertugrul and Hegde (2008);John, Mehran and Qian (2010);Ortiz-Molina (2007) ;Robicheaux, Fu and Ligon (2008)]. Zhang (2009) explores the substitutability of debt and equity-based compensation without incorporating the substitutability effect of leases.…”

“…To ensure robustness, we define market leverage as the book value of long-term debt (net of finance leases) divided by the adjusted market value of a firm. Prior studies have commonly separated leasing measures into finance and operating lease measures (e.g., Robicheaux, Fu and Ligon, 2008). Similar to debt, the long-term portion of leases are used and measured against a firm's adjusted book value (and the market value for robustness checks).…”

Independent Directors, Business Risk, and the Informativeness of Accounting Earnings for Debt Contracting

“…Therefore, we expect a positive sign on this variable (Ge, 2006;Robicheaux, Fu, & Ligon, 2008). Hence, we expect a negative sign on this variable.…”

Exercises of Executive Stock Options on the Vesting Date

“…Another factor potentially affecting early exercise is the liquidity need of the executive. Robicheaux, Fu, and Ligon (2008) find that the real value of executive cash compensation (i.e., salary and bonus) is essentially flat over the period 1992‐2004 but that the percentage of stock option compensation is significantly higher over the period 1992‐2004 versus the base year of 1992 (31.8% vs. 20.2%). Liu and Yermack (2007) find that CEOs frequently liquidate company shares and options to finance acquisition of new principal residences, and that the extent to which they do so is negatively correlated with future firm performance.…”