Substitutability of Leases and Debt in Corporate Capital Structures

Finance theory suggests that leases and debt are substitutes. Surprisingly, however, prior empirical research using financial statement data has been unable to verify this trade-off between the two forms of financing. This study re-examines the issue of substitutability by comparing changes in lease and debt financing over a six-year horizon for a large sample of U.S. firms. The empirical results strongly support the theoretical contention that leases and debt are substitutes and is thus consistent with evidence from surveys of lending officers. There is some evidence, however, that firms do not view leases as displacing nonleasing debt on a dollar-for-dollar basis.