Leasing as a Mitigation of Financial Accelerator Effects
Kai Li, Jun Yu
Review of Finance, Volume 27, Issue 6, November 2023, Pages 2015–2056, https://doi.org/10.1093/rof/rfad004
In this paper, we study the macroeconomic implications of corporate leasing activities.
Leased capital is extensively used in capital markets and production, but its effects on macroeconomic dynamics have been largely overlooked in the literature on macro models with financial frictions, which assumes that firms don’t have an option to rent capital. However, leased capital accounts for about 20% of the total physical productive assets used by US publicly listed firms, and its proportion is more than 40% among small and financially constrained firms. The leased capital ratio exhibits a strong counter-cyclical pattern over business cycles as well as a positive correlation with the volatility of cross-sectional idiosyncratic uncertainty.
As discussed in existing literature, leased capital differs from owned capital in two major aspects. First, according to US bankruptcy code, lessors have a stronger ability to repossess an asset than do creditors of secured lending. Due to the repossession advantage, lessors is willing to implicitly extend more credit than a lender whose claim is secured by the same asset. Thus, the debt capacity of leasing is larger than that of secured lending, which makes leasing more valuable in states with tighter financial constraints and for financially constrained firms. Second, due to the separation of ownership and control rights, leasing is more costly due to agency problems.
Based on those stylized facts, we explicitly introduce the key features of leasing activities into the Bernanke-Gertler-Gilchrist financial accelerator model setting, the first paper of doing so, to our best knowledge. In our model, financial frictions originate from a “costly state versification” (CSV) problem proposed by Townsend (1979), in which lenders must pay a verification cost to observe the borrower’s realized return on capital. We model the repossession advantage of leasing in a novel way, it is reflected by its ability to save verification costs. In our model, the key trade-off of leasing is therefore the advantage of saving verification costs and higher user costs due to the separation of ownership and control rights.
Using the quantitative results of the model, we demonstrate a novel and quantitatively important economic mechanism: in response to negative TFP shocks or positive risk shocks, the financial constraints become tighter, the benefit of larger debt capacity associated with leasing outweighs its higher cost, and firms increase their use of leased capital. As a result, although total capital (i.e., sum of leased capital and owned capital) stock still decreases, the reallocation towards leased capital mitigates the decline in capital, investment, capital prices, and also net worth, thereby weakening the financial accelerator effects. We provide strong empirical evidence to support our mechanism.
Our paper contributes to the literature in following ways: First, it provides a novel theoretical way of capturing the repossession advantage within the CSV framework, for the first time in literature. Second, it demonstrates a novel and quantitatively important economic mechanism, that is counter-cyclical usage of leasing can significantly mitigate the financial accelerator effects. Overall, our results highlight the importance of accounting for corporate leasing activities in macroeconomic studies.