Leasing, Uncertainty, and Financial Constraint

Abstract

Leasing is one of the most important sources of external finance to corporate firms. This paper develops a dynamic model to investigate the role of uncertainty and financial constraint in understanding the leasing decisions of corporate firms. The model predicts that firms with high uncertainty over their future profits and firms that are more financially constrained prefer to lease more of their capital than firms with low uncertainty and firms that are less financially constrained. Because of the agency costs originated from the separation of ownership and control, leasing is a more costly way of financing than owning capital. However, leasing provides firms with operational flexibility and leases are easier to finance than purchases. The benefits of leasing are particularly attractive to firms with high uncertainty and firms that are subject to more financial constraints. Using data on publicly-traded firms in the U.S., this paper provides evidence consistent with the prediction.