Owning Versus Leasing: Do Courts Matter?

Abstract

The authors develop a legal contract enforcement theory of the own versus lease decision. The allocation of ownership rights will minimize enforcement costs when the legal system is inefficient. In particular, when legal enforcement of contracts is costly, there will be a shift from arrangements that rely on such enforcement (such as a rental agreement) toward other forms that do not (such as direct ownership). The authors then test this prediction and show that costly enforcement of rental contracts hampers the development of the rental housing market in a cross-section of countries. They argue that this association is not the result of reverse causation from a developed rental market to more investor-protective enforcement and is not driven by alternative institutional channels. The results provide supportive evidence on the importance of legal contract enforcement for market development and the optimal allocation of property rights.