Leases and Over-investment

Abstract

What factors enhance investment efficiency in leased assets, and what incentives give rise to over-investments? If firms over-invest in leases, what economic consequences arise? We develop a model of expected investment in leased assets, and use the residuals from the model as proxies for inefficient investments. We find that, in contrast to investments in capital expenditures, leasing appears to be a mechanism for over-investment even among firms with high reporting quality and negative free cash flows. Examining economic consequences, we predict and find that over-investments in leased assets trigger increasing future sales growth but declining future earnings growth for as long as three years ahead. We also find a negative relation with contemporaneous stock returns, suggesting investors view over-investments in leases as value destructive. Finally, despite negative earnings and returns consequences, we find that over-investments in leases are associated with higher CEO compensation driven primarily by future sales growth. Our results should inform investors, board members, and researchers interested in investment efficiency, corporate governance, and leases.

Keywords: Leases, Over-investment, Corporate Governance, Compensation, Sales and Earnings Growth, Stock Returns