Do operating leases expand credit capacity? Evidence from borrowing costs and credit ratings

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Vol. 42; pp. 100 - 114
• Main Authors: Lim, Steve C., Mann, Steven C., Mihov, Vassil T.
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01-02-2017
• Subjects: Cost of capital; Credit capacity; Off-balance sheet financing; Operating leases; Off-balance sheet financing; M41; Operating leases; G32; Cost of capital; Credit capacity
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2016.10.015

We document that borrowing costs and credit ratings are less sensitive to off-balance sheet lease financing than to on-balance sheet debt financing, particularly for firms that are financially constrained and firms that have limited ability to use tax shields. This evidence is consistent with theoretical predictions based on tax benefits as well as bankruptcy costs. Our evidence on borrowing costs and credit ratings suggests that credit markets treat operating leases differently from balance sheet debt. Consistent with this interpretation, we document that firms closer to ratings borderlines lease more, particularly around the investment grade borderline.
•We examine the benefits of off-balance sheet operating leases in extending credit capacity.•We compare the effect of debt and leases on the cost of bank loans and public debt, and on credit ratings.•Borrowing costs and credit ratings are less sensitive to lease financing than to debt financing.•This effect is stronger for financially constrained firms, or firms with lower marginal tax rates.•Firms close to ratings borderlines lease more, particularly around the investment grade border.