Leasing, Ability to Repossess, and Debt Capacity

Abstract

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.

Bank size, lending technologies, and small business finance

“…Based on this approach, we are reasonably certain of the identification of the technology used for over 40% of the loans -term loans using valuations of fixed assets leased or pledged as collateral. Researchers often focus on 4 It oversamples certain types of firms, including larger small businesses, which have been shown to use leasing less often than smaller firms (see Eisfeldt and Rampini, 2009). 5 About 13% of the bank loans are excluded because the bank could not be determined.…”

“…11 The argument that leasing provides a more perfect lien than pledging collateral on fixed assets is not new. Eisfeldt and Rampini (2009) argue that the benefit of leasing is that repossession of a leased asset is easier than foreclosure on the collateral of a secured loan.…”

Why are firms unlevered?

“…Holmstrom and Tirole (1998) suggest that constrained firms are likely to rely on bank financing in order to tide over liquidity shocks. Eisfeldt and Rampini (2009) find that constrained firms are more likely to lease their assets rather than use debt financing to purchase them, since in a bankruptcy, the U.S. bankruptcy code makes it easier for a lessor to repossess leased assets than for a secured lender to repossess collateral. Many capital structure studies (Coles et al, 2006;MacKie-Mason, 1990;Molina, 2005) use a measure of tangible assets as an explanatory variable.…”

The real estate risk of hospitality firms: Examining stock-return sensitivity to property values

“…13, the benefits and risks of owning real estate are not significantly transferred from lessor to the lessee through operating leases. Eisfeldt and Rampini (2009) argued that the operating lease is the only 'true' lease, as the lessor retains effective ownership of the asset. Also, an operating lease is more flexible and more easily reversed, as the lessee can either assume or reject the lease.…”