Leasing Versus Purchasing

2-17-2011

06-01: Leasing versus purchasing

This paper examined the relationship between the lessee’s economic gains from leasing and the lessee’s effective tax rate and its external financing costs. Corporate leasing implies to us that using and owning an asset to support an investment project are very much separate economic activities. Although if firm A has a comparative advantage in owning the asset, the lease may enable the user to outsource its ownership to that firm. The difference between the NPV of the project if it is leased and the NPV of the project if it is purchased is the gain that the lessee can get from it. Of all the possible choices, secured debt is most closely related to leasing.

The paper talked about how the coexistence of both leased and purchased assets that are in the same firm shows us that the benefits of leasing are neither positive or negative. From this we can see that if two firms have identical tax situations and costs of external financing may still have different leasing policies. Sharpe characterized firms in their tendencies to lease and he found out that there is about a 20% variation in their tendencies that can be explained by regressions that include proxies for taxes and external financing costs.

This paper showed us that lessee equity values increase when new sale and leasebacks are announced. The paper also explained that lessee equity values remained unchanged when new direct leases are announced.

2-17-2011

06-02: CEO Ownership, Leasing, and Debt Financing

The financial contracting theory says that such company characteristics as business risk and the nature of the investment opportunity set should affect contracting costs and thus the choice to lease rather than buy assets. Theoretical literature has also given us the idea that a corporation’s ownership structure, which can and does affect managerial and investor incentives, should influence the idea to lease assets.

This paper examines the ownership structure in the way that it is measured by the fraction of common shares owned by the company’s chief executive officer. The paper also includes some variables that affect business risk. These are investment opportunities and tax considerations.

The main addition that this paper covered that others in the past had not touched on was to include a variable measuring top management share ownership in equations that are intended to explain both corporate leasing and debt financing. This paper’s estimate indicated that CEO ownership has a significant positive effect on both debt financing and leasing. The CEOs interests are more closely aligned with shareholders when they have larger ownership stakes. The CEOs also seem to have a greater incentive to use debt-financing when it is value-enhancing to do so.