The Leased Capital Premium

Abstract

This paper demonstrates a novel risk premium channel for firms' dynamic lease versus buy decision. In a typical operating lease contract, a less financially constrained lessor (capital owner) effectively provides an insurance mechanism to a more constrained lessee (capital borrower) against the risk of capital price fluctuations. As a result, we provide an new insight that, though leasing is a critical element of firms' liability, leasing and financial debt have opposite implications for firms' equity risks and cost of capital. In particular, the leased capital is less risky than the purchased capital through secured financial loans. We provide strong empirical evidence to support this prediction. Among financially constrained stocks, firms with a low leased capital ratio earn average returns 7.14% higher than firms with a high leased capital ratio. We develop a general equilibrium model with heterogeneous firms and financial frictions to quantitatively account for the negative leased capital premium.

Keywords: Leased capital, Operating lease, Secured debt, Collateral, Financial constraint, Cross-section of returns

JEL Classification: E2, E3, G12