Anna Maria C Menichini, and Maria Grazia Romano
Review of Finance, Volume 29, Issue 6, November 2025, Pages 1871–1907, https://doi.org/10.1093/rof/rfaf039
Leasing is widely used across capital-intensive industries and accounts for a large share of equipment and software financing in both the US and EU.
Given that leasing allows firms to finance up to 100% of the purchase price of an asset without additional collateral or guarantees, it should be particularly attractive to financially constrained firms. Yet small firms do not rely on leasing significantly more than larger ones – a notable puzzle.
The authors argue that the interaction between the incentive problems related to asset management, particularly maintenance and use, and financial constraints may drive the firm’s decision between purchasing and/or leasing productive assets, providing a rationale for the limited reliance on leasing by small firms. They propose a one-period model in which firms choose how much to invest in a collateralizable input and how to finance it, whether through secured lending, leasing or a combination of the two. Asset management involves two types of effort: usage during production, affecting depreciation, and maintenance after production, preserving resale value.
Collateral constraints arise endogenously due to the non-contractibility of maintenance: when a large fraction of the asset is pledged, a defaulting entrepreneur may forgo maintenance, causing asset depletion and reducing collateral value. To preserve maintenance incentives, lenders reduce loan size, leading to underinvestment. Leasing contracts bundling financing with maintenance restore maintenance incentives – the lessor always maintains the asset – and mitigate credit rationing. However, leasing induces another agency problem: lacking the ownership, the lessee exerts insufficient effort in asset usage and correct incentives must be provided through costly audits.
The mix of secured lending and leasing in the firms’ financial structure depends on the severity of the incentive problems.
Sufficiently wealthy firms, those with W? W2 in the figure, needing small loans, pledge a tiny fraction of the asset as collateral and always have the incentive to carry out maintenance. They thus purchase the first-best level of the capital input.
Less wealthy firms, those with W<W2, need to pledge a fraction of the asset that is too large to preserve maintenance incentives and are credit rationed. While those with W1BR?W<W2 underinvest, purchasing the capital input with secured lending (upward sloping red line), those with W0BR?W< W1BR compensate the investment reduction (dotted red line) by leasing (dotted blue line). This reduces financing needs, preserves maintenance incentives on purchased capital and ensures correct usage of leased capital at low audit cost. Thus, leasing mitigates underinvestment by enabling higher capital levels (constant green line) than secured lending alone. Leasing and secured debt are complements in this case. Finally, severely rationed firms, those with W<W0BR, can no longer sustain maintenance incentives by downsizing investment and rely on a single financing source depending on their prospects. Because audits occur only under high demand, when the asset is intensively used, firms with bad prospects face lower audit costs than those with good prospect. The former lease (constant blue line), while the latter buy (constant red line). Leasing may therefore be non-monotonic in financial constraints, helping explain why small firms may not rely more on leasing despite tighter financing conditions.
Figure 1
