Secured lending versus leasing: the role of asset management in capital structure

Abstract

We propose a theory of leasing where incentive problems in asset use and maintenance , along with borrowing constraints, shape firms’ renting decision. When secured lending finances asset purchases but the owner’s uncontractible maintenance determines its residual value, collateral constraints endogenously arise due to privately unprofitable maintenance, causing asset depletion and credit rationing. Leasing contracts bundling financing with maintenance restore maintenance incentives, but create agency problems on the lessee, who may choose insufficient care in asset usage. We find that leasing mitigates credit rationing and facilitates secured lending. However, contrary to conventional wisdom, it may be non-monotone in financing constraints, explaining small firms limited reliance on it. We provide novel testable predictions regarding the use of leasing in different industries.