Leasing and debt financing: Substitutes or complements?

Traditional finance theories typically treat leases and debt as substitutes. However, the empirical findings on the relation between leases and debt are mixed. This paper reinvestigates this relation. I present a model to incorporate different theories on the substitutability and complementarity between leases and debt, and I test the model implications empirically in a GMM framework that simultaneously controls for endogeneity problems and firms' fixed effects. The findings suggest that leases and debt are substitutes instead of complements. I also investigate the variation in the substitutability between leases and debt, and find that in those firms with more growth options or larger marginal tax rates, or in those firms paying no dividends, the substitutability is more pronounced, i.e., the cost of new debt increases to a larger degree with extra leases.