Leasing as a Mitigation Channel of Capital Misallocation

Abstract

We document that leased capital accounts for about 20% of the total productive physical assets used by U.S. public listed firms, and this proportion is even higher among small and financially constrained firms - over 40%. However, operating lease has been recorded as an off-balance-sheet item until the recent IFRS 16 lease accounting rule change (effective from 1 January 2019). Therefore, leased capital is an important ''unmeasured'' capital which leads to a significant mis-measurement in firms' capital productivity, and in quantifying capital misallocation (Hsieh and Klenow, 2009). In this paper, we argue that leasing is an important mitigation channel of credit-constraint-induced capital misallocation. First, we develop a general equilibrium model with heterogeneous firms, collateral constraint and an explicit buy versus lease decision to demonstrate a novel economic mechanism: the possibility for firms to rent capital when they are financially constrained mitigates capital misallocation. Second, we empirically show that ignoring leased capital and its mitigation effect leads to a significant overestimate of capital misallocation.