Summaries of recent and interesting research papers

Leasing vs. banking debt

Three professors from Lille1 have studied the consequences for existing creditors of a company's decision to use lease financing. As we know, lease financing has at least three effects:

• It penalises current creditors as existing, unsecured debt is demoted: the asset involved in lease is not one of the assets that creditors can seize in the event of liquidation, whereas if the asset had been financed by bank debt it could be seized;
   
• On the other hand, creditors have greater control over the risks to a company's operating assets, as the company cannot sell leased assets and replace them with riskier assets, which would reduce the value of debt and increase the value of equity;
   
• The company gives up some operating flexibility, as it is no longer the master of its assets. But this is offset by leasing's advantage of full financing without additional equity, as well as its speed and flexibility in application...

Based on a survey of 721 Belgian companies, the authors found that:

• Companies seem to diverge widely in their financing strategies. Either they make little use of leasing (half of them use it for less than 10% of their bank financing) or heavy use of it (20% of them use it for more than 90% of their bank financing). Few companies fall between these two extremes. The authors suggest that when leasing accounts for a high proportion of bank financing, banks ration out conventional credit as the company's risk profile has worsened. The company is then encouraged to make even greater use of leasing and some of them even begin to use it almost exclusively.
   
• The non-leasing banker demands greater collateral as the proportion of leasing in company financing increases, to reflect the resulting decline in the quality of its debt.

All things considered, this study reminds us that it is a serious mistake in finance to consider only the cost of the source of marginal financing without regard to its impact on the cost of existing resources.

(1) Eric de Bodt, Marie Christine Filareto and Frédéric Lobez, Banques & Marchés n° 54, September-October 2001.