Additional evidence on the lease choice decision : a study incorporating the use of synthetic leasing

Abstract

I reexamine the incentive trade-offs embedded in the lease choice decision, considering both the conventional operating and capital lease choices, as well as a third lease choice, synthetic leasing. A synthetic lease combines the tax benefit of a capital lease with the off-balance sheet advantages of an operating lease. Empirical studies of incentive trade-offs in the leasing context assume that the lease choice is driven by a preference for one incentive over the other. But the mere existence of synthetic leasing suggests that some high marginal tax rate firms also want the advantages offered by off-balance sheet financings.|The addition of synthetic leasing as a lease option, however, introduces a third incentive. At the end of a synthetic lease, the lessee must either purchase the asset or arrange for its sale. This obligation presents a non-trivial risk due to the potential for interest rate increases and/or property value declines.|In order to accommodate the endogenous relation of the leasing options, I employ a sum-constrained tobit model embedded in a recursive simultaneous equations model. I find the anticipated inverse relation between tax incentives and operating lease choice. A counter-intuitive inverse relation, however, is found between financial reporting incentives and operating lease choice. Consistent with prior research, I find no significant relation between either financial reporting or tax incentives and the use of capital leases for larger firms. And in the decision to utilize synthetic leasing, I find a significant direct relation with both financial reporting and tax incentives. I find no significance relating to the end-of-lease obligation associated with a synthetic lease.