Do Leases Expand Debt Capacity
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Do Leases Expand Debt Capacity
Do Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacitys for the authors are finjs@business.utah.edu. kwellsigdixie.edu. and ryan.whitby@usu.edu. We thank Mike Lemmon for helpful discussions and (he seminar participants at University of Canterbury. Christchurch. New Zealand, the University of Kentucky, and the University of Montana for helpful suggestio Do Leases Expand Debt Capacityns. We are responsible for all remaining errors.Do Leases Expand Debt Capacity?ABSTRACTTheoretically and empirically, debt and leases have been shownDo Leases Expand Debt Capacity
10 be both substitutes and complements. To explore the relation, we divide our sample into two subsets: those that exhibit a complementary relation (4Do Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacitynt firms, we find a significant negative relation between leasing and the firm’s size, marginal tax rate, and z-score, consistent with “complementary” theories. For substitute firms, we find a positive and significant relation between leasing, the marginal tax rate and changes in cash. We also find Do Leases Expand Debt Capacitya significant positive stock market reaction to the announcement of the SLB. which is stronger for the complement subset of firms.1. IntroductionMostDo Leases Expand Debt Capacity
theoretical models of leasing have assumed that leases substitute lor debt in the sense that more leasing should result in less debt because leases usDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacitysfeldt and Ranipini (2009) predict the possibility that debt and leases can be complements, and that leases can actually increase debt capacity, by utilizing theories based on taxes or bankruptcy costs, respectively. In tills paper, we carefully examine firms that exhibit a complementary relation be Do Leases Expand Debt Capacitytween debt and leases, and contrast them with firms that have a more traditional substitutionary relation between debt and leases.Ang and Peterson (19Do Leases Expand Debt Capacity
84) find that firms that use more leases tend to have, in fact, more debt and label their finding the “leasing puzzle." A body of literature has develDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityltz (1986). Marston and Harris (1988). Beattie. Goodacre, and Thomson (2000), and Yan (2006) all find that debt and leases are substitutes, with varying degrees of substitutability. One of the problems with the literature that examines this issue previously is the familiar ceteris paribus condition; Do Leases Expand Debt Capacity the assumption that all else remains equal is problematic because almost all leases involve the acquisition of a new asset lor the firm. One exceptioDo Leases Expand Debt Capacity
n is the salc-and-lcascback (SLB) transaction. in which the assets of the film do not change because of the leasing transaction. Willie films can makeDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacity financial. We employ a lai-gc sample of hand-collected SLBs and then observe the firm’s actions after the transaction to determine differences between firms that use debt and leases as substitutes or complements. That is, we are able to observe whether firms1increase or decrease their debt and cate Do Leases Expand Debt Capacitygorize our sample firms as either members of the complement subset or substitute subset.The following examples of SLB transactions and the subsequentDo Leases Expand Debt Capacity
debt changes illustrate the differences. In 1998, Nike. Inc. completed the SLB of a distribution center to TriNel Corporate Realty Trust, Inc. FollowiDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityclear example of a substitutionary relation. In 1999, Famous Dave’s of America, Inc. completed the SLB of three restaurant locations to Franchise Financial Coip. of America. The SLB transaction was for S5 million. Following this transaction, Famous Dave’s long-term debt increased by S8.4 million whi Do Leases Expand Debt Capacityle its total debt increased by S4.1 million (total debt includes issuance less retirements). Thus, while some firms clearly treat debt and leases as sDo Leases Expand Debt Capacity
ubstitutes, other firms treat debt and leases as complements. To our knowledge, this study is the first to separate and examine a subgroup of firms thDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityer a SLB transaction. We find that over 42 percent of the 392 firms in our sample exhibit a complementary' relation. For this group, we find firms tend to have higher debt ratios, higher market to book ratios, and more capital expenditures than the substitute subset. While many of the SLB transactio Do Leases Expand Debt Capacityns we examine involve real estate - about 63 percent of the overall sample -real estate is not a driving factor between our two subsets. Although it iDo Leases Expand Debt Capacity
s interesting to note the differences between the two subsets, much of our analysis focuses on the relation between debt and leases within each subsetDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityirm. The result, however, is not robust to different definitions of2https://khothuvien.cori!debt. Given the significant proportion of firms in our sample that increase debt after the SLB transaction, this result is not surprising.For the substitute subset, a dollar of SLBs appears to substitute for Do Leases Expand Debt Capacityapproximately S0.73 of total debt. When examining only the long-term debt in the substitutionary subset, a dollar of leases appears to substitute forDo Leases Expand Debt Capacity
approximately $0.54 of long-term debt. The substitute subset also exhibits a significant decrease in the ratio of capital leases to operating leases, Do Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityes and financial constraints as posited by the Lewis and Schallheim (1992) and Eisfeldt and Rampini (2009) theories. According to our analysis of the complement subset, the marginal tax rate is significantly and negatively associated with the amount of the SLB. We also find support for an associatio Do Leases Expand Debt Capacityn between SLBs and financial constraints (z-scone) for this subgroup. Furthermore, the complement subset of firms do not display a change in the ratioDo Leases Expand Debt Capacity
of capital leases to operating leases, indicating that they are less concerned with accounting leverage ratios than the substitudonary subgroup.To exDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityr the total sample and for each subset. We also perform an event study analysis of the market’s reaction to the announcement of the SLB transactions and find an overall positive return of 1.61 percent. The stock market reaction is stronger for the complement subset than for the substitute group.One Do Leases Expand Debt Capacityof the main takeaways from our analysis concerns the results for the complementary' subset. Within the group of firms that increase debt after the SLBDo Leases Expand Debt Capacity
transaction, there is an increasing relation among leasing and firm size, Allman’s z-score, and the marginal tax rate.3These results are consistent wDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacityis paper is organized as follows: Section 2 describes the theoretical and empirical literature related to leasing and SLBs. Section 3 discusses our testable hypotheses, Section 4 describes our sample of SLB transactions, and Section 5 presents our results. We state our conclusions in Section 6.2. Li Do Leases Expand Debt Capacityterature related to leasing and sale-and-leasebacks2.1. Leasing theoryUnder the assumption of perfect capital markets, Modigliani and Miller show thatDo Leases Expand Debt Capacity
the method of financing is irrelevant to the total value of the firm given the investment opportunity set. The notion that debt and leases are substiDo Leases Expand Debt Capacity?James SchallheimUniversity of UtahKyle Wells Dixie State CollegeRyan Whitby Utah State University41365♦ Email addresses Do Leases Expand Debt Capacitynce of corporate taxes, the choice between debt and leases can be irrelevant given common tax rates and no other market imperfections. In the MDB model, leasing can be advantageous to both parties of a transaction if the tax rates between lessor and lessee differ.1 The MDB model has a parameter, Ầ, Do Leases Expand Debt Capacitywhich represents the substitution between debt and leases. The values for Ă range between 0 and 1. In other words, the substitution between debt and lDo Leases Expand Debt Capacity
eases may be dollar for dollar, or a dollar of leases may substitute for less than a dollar of debt. However, MDB never consider the possibility thatGọi ngay
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