A Test of the Substitution between Debt and Leases Using Sale-and-Leaseback Transactions

Abstract:     
Most theoretical models predict that debt and leases should act as substitutes. While the preponderance of evidence supports this claim, there remain significant cases where debt and leases appear to be complements. One of the problems with prior research is that it is difficult to properly control for the changing asset base associated with leasing in cross-sectional tests. To overcome this problem, we examine a sample of sale-and-leaseback (SLB) transactions where the assets of the firm do not change due to the lease. We find evidence of a substitution effect between leases and long-term debt in our overall sample. We also find, however, that 40 percent of the firms exhibit evidence of a complementary relation by increasing their debt after the SLB transaction. To further explore this relation we divide the sample into two groups, those that show an increase in debt and those that show a decrease in debt after the SLB transaction. Within the substitute subgroup, leasing is associated with more capital expenditures and financial constraints. Within the complement subgroup, we find a significant relation between leasing and the firm's marginal tax rate.

Number of Pages in PDF File: 25

Keywords: Leasing, Capital Structure

JEL Classification: G31, G32

working papers series