School of Management & Languages
Heriot-Watt University
Edinburgh, EH14 4AS
Tel:
Fax:
Mail:
Web:
+44(0)131 451 3542
+44 (0)131 451 3079
[email protected]
www.sml.hw.ac.uk
School of Management and Languages
The Role of Leasing in UK Corporate Financing Decisions
Sarah Jane Thomson
Discussion Paper Series in Accountancy & Finance
ISSN 1741-8232
DP2004-AF04
Aug-05
The Role of Leasing in UK Corporate Financing
Decisions
Sarah Jane Thomson
Heriot-Watt University
(Email: [email protected])
Draft date: June 2005
Address for correspondence:
Sarah Jane Thomson
Department of Accountancy and Finance
School of Management and Languages
Heriot-Watt University
Riccarton Campus
Edinburgh
EH14 4AS
UK
Email: [email protected]
The Role of Leasing in UK Corporate Financing Decisions
ABSTRACT
Leasing provides a significant source of finance across European firms, especially those in the
UK. Historically, its use has been attributed to favourable accounting and tax treatments, both
of which have eroded over time and may soon be further eroded. Lease accounting treatment
is currently under review. The UK is undertaking a project to inform the International
Accounting Standards Board. Proposals (ASB, 1999) essentially remove the ‘off-balance
sheet’ accounting treatment of operating leases. Furthermore, the UK tax authority has
proposals to award capital tax allowances to lessees rather than lessors as part of corporation
tax reform. If accounting and/or tax treatments currently provide incentives to use operating
leases, the role of leasing may subsequently change.
This paper offers survey evidence on the leasing decision across UK listed companies. The
results, based on 198 responses, show that avoiding large capital outlay and cash flow
considerations are of paramount importance for the group as a whole in the decision to lease
all asset types. However, the current accounting treatment and the award of capital allowances
to the lessor are the most important factors for significant sub-groups of companies. Given
that accounting and tax treatments are of key importance for a wide range of companies in
terms of size, gearing and industry classification, the extent to which proposed changes will
influence leasing activity is difficult to predict. However, the importance attached to reasons
other than accounting and taxation indicates that the popularity of leasing as a source of
finance is set to continue.
Keywords: leasing decisions, operating leases, UK listed companies, questionnaire survey
2
The Role of Leasing in UK Corporate Financing Decisions
1. Introduction
Lease use is both significant and widespread across European firms. In 2003, it accounted for
more than 14% of gross fixed capital formation in Europe, and new business amounted to 193
billion euros (Leaseurope, 2003). The UK accounted for 17% of total European leasing
activity, coming second to Germany (22%) and matching the level undertaken in Italy. Why
do firms obtain the use of business assets through leasing, rather than borrowing to finance
purchase?
A range of theoretical reasons for leasing, such as accounting treatment, tax savings,
borrowing capacity, repayment and risk sharing, exist in the literature. However, related
empirical evidence generated via survey and regression modelling is incomplete for several
reasons. First, the majority of UK studies providing direct evidence through survey
investigation were conducted before the introduction of accounting regulation and prior to the
current tax status. The nature of lease agreements has altered over time. ‘On-balance sheet’
finance leases provided the focus for the majority of prior research and such leases are now in
relative decline. ‘Off-balance sheet’ operating leases appear to be a growth market, providing
a significant source of finance for UK firms. For example, for the top 100 UK listed
companies 2002/03 year-ends, the median ratio of operating lease liability to debt was
estimated at 0.11, and the median ratio of operating lease liability to finance liability was 6.2
(Beattie, Goodacre and Thomson, 2004). Second, studies that provide indirect evidence by
investigating the characteristics of UK leasing firms are limited, both in number and in the
extent to which qualitative reasons can be investigated. Third, UK findings also appear to
conflict with similar studies of US firms. However, as Bancel and Mittoo (2004) highlight,
managerial motivations are unlikely to remain static, creating difficulties in interpreting
evidence from studies conducted in different time periods and addressing different aspects of
the leasing decision.
Historically, leasing use has been significantly attributed to its ‘off-balance sheet’ accounting
treatment. If this explains the use of operating leases in the current climate, then the role of
leasing in future financing decisions may change if this ‘off-balance sheet’ treatment is
removed. Many accounting standard-setting bodies have considered this option. In 1996, the
G4+1 group published a report (McGregor, 1996) which formed the basis of a discussion
paper in the UK, ‘Leases: implementation of a new approach’ (ASB, 1999). It is proposed that
all leases should be recognised on the balance sheet rather than just finance leases. The UK is
currently undertaking a project on lease accounting to inform the International Accounting
3
Standards Board (IASB website, visited April 2005). The future recognition of all lease
agreements ‘on-balance sheet’ is not beyond the realms of possibility. Leasing use has also
historically been associated with tax treatment through legal ownership, with the right to
claim capital tax allowances remaining with the lessor. Tax treatment now looks set to change
dramatically with the Inland Revenue intending to switch the award of capital tax allowances
from lessors to lessees in a financing arrangement, as part of a reform of the UK corporation
tax system (HMSO, 2003).
The aim of this paper is to investigate whether theoretical explanations for leasing translate
into practice, and to assess the relative importance of financial and non-financial factors in the
decision to lease in the current climate. A questionnaire survey of UK finance directors is
used to allow a wide range of potential influential factors to be considered. This paper
contributes to the understanding of lease financing by providing comprehensive up-to-date
evidence of leasing decisions across UK listed industrial companies. This paper also provides
policy-relevant ex ante evidence in support of the standard setting process (as advocated by
Schipper, 1994) by providing an indication of the potential consequences of intended changes
to the lease accounting and tax regulations.
The remainder of this paper is structured as follows. Section two provides a literature review
on the rationale for leasing. Section three outlines the method employed, including sampling
and data collection procedures. Empirical analysis of results is presented in section 4 and
summary and conclusions are presented in the final section.
2 Literature review
2.1 Theoretical reasons for leasing
Several authors have considered reasons why leasing may be considered preferable to
financing purchase by non-leasing debt alternatives. These reasons are grouped into six
categories: accounting treatment; tax savings; borrowing capacity; repayment; risk sharing
and other reasons.
2.1.1 Accounting treatment
At present, both UK (SSAP 21, ASC 1984) and international lease accounting standards
(IAS17) require the capitalisation of only finance leases. Thus, operating leases could be
4
favoured for their ‘off balance sheet’ nature as rental payments are expensed in the profit and
loss account, with neither the leased asset nor leased liability appearing on the balance sheet.
Under SSAP 21, finance lease classification requires the present value of minimum lease
payments to be 90% or more of the fair value of the leased asset. This 90% test is said to be
open to manipulation and provides the opportunity for lease agreements to be classified as
operating leases. Further, UK managers appear unwilling to disclose methods used in lease
classification (Loveday, 1994). Tweedie and Whittington (1990, p.88) noted, when
considering problems in financial reporting, that there are companies ‘whose effective asset
base and liabilities are not wholly on the balance sheet as a result of the extensive use of
leasing and the arbitrary nature of the leasing standards rules’.
2.1.2 Tax savings
At present, legal ownership and the right to claim capital tax allowances on qualifying plant
and machinery remains with the lessor. If the lessor can make better use of capital tax
allowances than the lessee, then potential lessees may be enticed with the offer of lower rental
payments (Smith and Wakeman, 1985; Schallheim, 1994; Belkaoui, 1998; Day, 2000).
Capital tax allowances normally involve a 25% writing down allowance. However, capital
expenditure in respect of finance leases is now time apportioned in the first year and the
writing down allowance is reduced to 6% in respect of long-life (25 year) capital expenditure
(1997 Finance Act). Tax savings on behalf of the lessee may still arise, even though an asset
does not qualify for capital allowances because lease rentals paid are tax deductible. Although
the increased cost of lease rentals, imposed to compensate the lessor for the absence of capital
allowances, may reduce the tax savings, leasing can still potentially be beneficial. This is
especially true if the lessee makes rental payments in respect of commercial buildings/offices
and if the lessor is of non-tax paying status.
2.1.3 Borrowing capacity
Leasing might be used to extend a firm’s capacity for borrowing if managers perceive that
leasing obligations consume less or even no debt capacity compared to non-leasing debt
alternatives (Schallheim, 1994; Day, 2000). Further, lease agreements may contain less
restrictive covenants and thus have less impact on obtaining future finance (Smith and
Wakeman, 1985; Schallheim, 1994; Day, 2000).
5
2.1.4 Repayment
Leasing may be favoured in terms of cash flow considerations. It provides 100% finance for
an asset with a limited deposit of a rental payment in advance. Lease agreements are flexible,
incorporating features such as balloon rentals to enable repayment to accommodate
fluctuations in cash flows (Schallheim, 1994; Day, 2000).
2.1.5 Risk sharing reasons
Operating leases are said to reduce the risk of obsolescence and provide the flexibility to
obtain modern or upgraded equipment (Smith and Wakeman, 1985; Schallheim, 1994;
Belkaoui, 1998; Day, 2000). If lessors have a diversified portfolio, then the cost of
obsolescence can be borne more cheaply, reflected in the cost of rental payments. Lessors
may be in a better position to acquire standardised assets, which they supply to numerous
lessees, through bulk purchase (Smith and Wakeman, 1985; Schallheim, 1994; Day, 2000).
This could be beneficial to small firms who suffer from diseconomies of scale. However,
large firms may themselves be in a better position to acquire purchase discounts, and the
introduction of the lessor, a third party between the buyer and seller may actually result in a
higher purchase price. This may not necessarily deter large firms from leasing if they can
achieve the ‘best of both worlds’ through sale and lease back arrangements. Lessors may have
easier access/more opportunity to dispose of equipment at the end of a lease agreement, which
could be reflected in lower rental costs, or benefit lessees if they participate in disposal
proceeds. Leasing eliminates the risk of significant costs of transferring ownership. This is
beneficial in relation to the transfer of ownership of assets such as property, when the legal
fees and taxes are significant.
2.1.6 Other reasons
Leasing can be arranged for any size of operations. It is equally available for individual
assets, smaller scale operations and larger scale acquisitions; whereas medium/long-term debt
is usually arranged on a large scale (Schallheim, 1994; Belkaoui, 1998). Operating leases
might be classed as revenue expenditure and thus has the potential to avoid the formal
sanctioning process applicable to capital expenditure (Schallheim, 1994; Day, 2000).
It is suggested that the application process for lease finance is easier than with other sources
of finance, and carries minimum paper work (Day, 2000). Also, leasing is conveniently
offered at points of sale. The overall cost of an asset may be reduced if a manufacturer offers
6
advantageous lease terms. It is also suggested that leasing can provide an economical means
of obtaining excellent servicing and maintenance of equipment (Belkaoui, 1998).
2.2 Empirical evidence
2.2.1 Survey evidence
The majority of UK survey evidence was obtained before the introduction of SSAP 21 in
1984 and prior to the current tax status. Fawthrop and Terry (1975) investigated how UK
corporate financial managers perceived and used leasing. They found that the relevance of
factors in determining the use of leasing varied across companies and concluded that leasing
policies are a product of individual financial circumstances. Sykes (1976) found leasing to be
used mainly because of cash flow advantages, although large companies (annual
turnover>£1000million) attached some importance to tax allowances. Tomkins, Lowe and
Morgan (1979) found that only a minority of small companies engaged in leasing mainly to
avoid capital outlay, or because no other sources of finance were available. Hull and Hubbard
(1980) concluded that non-tax paying reasons for leasing are important and that incorrect
lease evaluation affects leasing use.
In the aftermath of SSAP 21 and changes to the UK tax system, Mayes and Nicholas (1988)
found a predominant use of finance leases. The use of leasing to avoid large capital outlay
appeared to be of most importance to smaller firms and tax advantages were more important
to larger firms. These findings were confirmed by Drury and Braund (1990) who documented
that the relative cost of leasing, along with tax considerations, appeared to dominate the
leasing decision for large firms; little importance appeared to be placed on other qualitative
and cash flow considerations. Although cost considerations were also dominant for smaller
firms, they also appeared to attach importance to qualitative and cash flow factors.
In the US, O’Brien and Nunnally (1983) found that both tax reasons and risk sharing reasons
in terms of residual values and obsolescence were considerations in the leasing decision.
Mukherjee (1991) found that avoiding the risk of obsolescence appeared to be the most
important advantage to leasing, followed by a lower cost compared to borrowing. The tax and
‘off-balance sheet’ advantages to leasing appeared to be insignificant. Bathala and Mukherjee
(1995) found that lease covenants appeared to be less restrictive than those imposed by other
creditors. Small firms appeared to favour leasing for ‘off-balance sheet’ advantages, and the
provision of 100% financing.
7
2.2.2 Indirect evidence
Several studies analyse company accounting data using regression analysis to identify firm
characteristics that appear to be associated with leasing and non-leasing firms. In the US,
Kare and Herbst (1990) found financial gearing to be higher for leasing firms and leasing
firms to be of larger size. Krishnan and Moyer (1994) also found leasing firms to have higher
levels of long-term debt, as well as higher growth rates, lower retained earnings, lower
interest coverage and higher operating risk. Further, firms in manufacturing were found to
employ less leasing than retailing, transportation and mining, whose assets are less firm
specific. They concluded that as bankruptcy potential increases, lease finance becomes
attractive.
In the UK, Lasfer and Levis (1998) found companies using finance leases to be larger in
terms of sales turnover and to exhibit higher gearing ratios and market to book ratios. Leasing
companies were found to have higher growth levels as measured by additions to other
tangible fixed assets. There was evidence to support the argument that leasing was used to
transfer capital allowances to lessors. In large companies, profitability, financial gearing and
taxation were found to be positively correlated with leasing, whereas in small companies the
leasing decision did not appear to be driven by profitability or taxation reasons, but by growth
opportunities. On balance, firms using finance leases appeared to have higher levels of
financial gearing, higher growth in assets and a lower ability to service debt, in comparison to
firms that didn’t. However, the profitability and investment opportunities experienced by
firms using finance leases in comparison to those who did not use finance leases was unclear.
Unfortunately this study excluded operating leases.
Several studies1 have provided evidence regarding relationships between leasing and other
firm characteristics, either by focusing on the determinants of leasing policy, or as a byproduct when investigating the extent to which lease and debt are substitutes. Although US
findings suggest that financial gearing is positively related to finance leasing, UK evidence
suggests that the relationship is negative when operating leases are also given consideration.
In the US and the UK, the existence of a linear relationship between leasing and firm size is
not clear. UK evidence suggests that firms at both extremes of the size spectrum employ less
leasing compared to firms of medium size. Although a positive relationship was observed
between liquidity and finance leasing for a sample of US firms, the relationship appears
8
negative for UK firms in relation to both finance and total leasing. In the US, firms in a high
tax position or with substantial cash flows appear to employ less operating leases. High levels
of leasing in US firms appear to be associated with operating in a national/international
environment, possessing a large proportion of fixed assets in relation to total assets, a high
financial distress potential and large proportion of managerial ownership. Industry
classification appears to exert influence on the use of leasing in both the UK and US. Leasing
is exceptionally prominent in the UK retail trade.
In summary, there is some evidence that ‘off-balance sheet’ accounting and tax reasons
influence the leasing decision. Although firms have failed to acknowledge that leasing is used
to expand debt capacity, total leasing obligations do appear to displace less than an equivalent
amount of non-leasing debt. There is US evidence to suggest that lease covenants are less
restrictive than debt covenants. Leasing appears to be favoured for cash flow considerations.
High technology firms appear to use more leasing, which coincides with the importance
placed on safeguarding against obsolescence. The convenience associated with the application
process for lease financing does not seem to be an issue. Suggestions that leasing is favoured
for availability on any scale, availability at point of sale, or avoidance of capital expenditure
application processes do not appear to be supported. Further, there is little evidence obtained
in relation to the lessor’s ability to acquire/dispose of assets being an advantage, or the
avoidance of significant transfer of ownership costs.
The differences found in the relationships between levels of leasing and other firm
characteristics in the US and UK may partly be due to differences in the time periods in which
previous studies were conducted, as well as differences in the proxies used. However, the
evidence arising from the UK is limited, the latest UK survey having been conducted over a
decade ago when finance leases predominated.
3. Methods and sample of respondents
3.1 Sample selection
The questionnaire was sent to the finance directors of a systematic sample, of two-thirds (831)
of the population of industrial and commercial UK listed companies contained in the UKQI
list on Datastream in March 2000.
9
3.2 Questionnaire design and administration
The content of the questionnaire was derived from an extensive review of existing theory and
empirical evidence (reviewed above). The initial draft was modified to incorporate useful
comments received during piloting (several finance directors, The Finance and Leasing
Association and The Association of Corporate Treasures participated in piloting). The
questionnaire generally used close-form questions and adopted a five-point Likert scale with
verbal anchors. Ten questions (120 question elements) relating to leasing decisions were
included. It was mailed in June 2000 accompanied by a covering letter explaining the purpose
of the survey and assuring the confidentiality of responses. Several techniques were adopted
to enhance response rate: clear questionnaire layout; piloting; personally addressed covering
letters (all finance director details were individually clarified by telephone) individually
signed; reminder letters sent 14 days after the initial mailing and another copy of the
questionnaire 28 days after the initial mailing to all non-respondents; stamped reply envelopes
(rather than pre-paid envelopes) and non-respondents were asked to return the questionnaire.
3.3 Respondent firms
A total of 198 completed questionnaires were received, 192 from the 831 mailed
(approximately 23% response rate) and 6 companies who requested a copy of the
questionnaire when replying to a questionnaire on a related topic.2 Of the remaining 639, 225
returned the questionnaire uncompleted, whilst 414 failed to acknowledge receipt. The
response is relatively favourable given the increasing questionnaire fatigue of corporate
personnel.3
Tests for response bias included a comparison of responding companies and the population of
UKQI companies on the basis of size (measured by total assets) and industry group. A chisquared test indicated that there was no statistically significant difference on the basis of
industry (chi-squared = 7.695 p=0.464). A 2-tailed t-test confirmed that the mean total assets
for the population and responding sample were not statistically significantly different.
Responses to key questions on leasing policy were compared for early responders to those of
late responders, using late responders as a proxy for non-responders (Oppenheim, 1966).
Responses to key questions (66 question elements) were further compared based on the
degree of operating lease use (measured by the ratio of operating lease rental expensed in the
profit and loss account to total sales).4 The number of significant differences (at the 10%
10
level) in responses given by early and late respondents and high and low operating lease users
were relatively few, and there was no indication of strongly opposing views.
3.4 Nature of further analysis
Questionnaire responses were analysed by firm size, financial gearing and industry, additional
data being obtained from Datastream.5 Respondents were divided into three equal groups for
size and gearing purposes (small, medium and large sized firms; and low, medium and high
geared firms), with firms in the medium categories being omitted from further analysis. Thus,
comparisons were made between large and small firms and low and high geared firms. Nine
industry groups were compared. Descriptive statistics are shown in Appendix 1.
4. Results
Responses to survey questions are first described under five headings: use of leasing; general
approach to the leasing decision, relative importance of factors in the decision to lease;
relative importance in decision not to lease; and lease agreement features. Responses are
further analysed by firm characteristics: size, financial gearing and industry. Finally, the
survey evidence is then considered in relation to the theoretical set of reasons for leasing.
Further consideration is given to accounting and tax treatments in light of anticipated changes.
4.1 Use of leasing
The popularity of leasing as a source of company finance is evident, with approximately 84%
of respondents indicating that their companies currently used, had previously used or would
consider using leasing.
The use of both finance and operating leases to acquire different business asset types is shown
in Table 1. The use of operating leases to acquire vehicles appears to be most popular.
Operating leases are also predominantly used / considered to acquire land and buildings and
office equipment. Finance and operating leases appear to be equally considered for computer
equipment. Only in the acquisition of plant and machinery are finance leases predominant.
This contrasts with prior research conducted after the introduction of SSAP 21 and changes to
the UK tax system, which document a predominance of finance leases (Mayes and Nicholas,
1988)
[Table 1]
11
4.2 General approach to the leasing decision
Approximately 70% indicated that the decision to lease was the product of a process of
quantitative analysis (rows 1-2, panel A, Table 2). The remainder indicated that their
company approached the leasing decision non-quantitatively, by preferring to lease certain
asset types or by relying on judgement and experience (rows 3-4). Quantitative analysis was
undertaken by 51% of respondents only if purchase would have been profitable (row 1),
inferring that leasing is a financing rather than an investment decision. Slightly more than half
of all respondents indicated that these decisions were taken centrally (row 1, panel B, Table
2).
[Table 2]
Despite the popularity of leasing among respondents, only a minority admitted to preferring to
lease assets whenever possible or adopting a target proportion of assets to be financed by
leasing (rows 8-9, panel B, Table 2). Habitual comparison with alternative sources of finance
is not apparent, with only 23% of respondents indicating that the leasing alternative was
considered in all asset financing decisions, and 35% indicating that only specific assets were
leased (rows 3& 5, panel B, Table 2). When leasing is compared with other sources, bank
borrowing appears to be most popular (row 1, panel C, Table 2). Approximately 35% of
respondents indicated that they take advantage of “good leasing deals” if/when they arise
(row 4, panel B, Table 2).
4.3 The relative importance of factors in the decision to lease
The relative importance of factors in the decision to lease both land and buildings and other
assets is shown in Table 3 (factors ranked in descending order of importance for land and
buildings). In all cases, mean responses were found to be significantly greater than 1, i.e. not
important at all.
[Table 3]
The most important factor in the decision to lease land and buildings was to avoid large
capital outlays (row 1). Conservation of cash flow (row 2) and the rate of interest implicit in
the lease compared to the cost of borrowing to purchase (row 3) were also considered very
important. These three factors were also considered most important in the decision to lease
other assets (rows 1-3). However, the rate of interest implicit in the lease was of paramount
importance in the decision to lease other assets. Responses to avoiding large capital outlay
being important in the decision to lease land and buildings and other assets were significantly
different (row 1). Avoiding large capital outlay appears to be more important in leasing land
and buildings which is hardly surprising considering the purchase of land and buildings would
12
probably involve a greater capital outlay than the purchase of most other assets. A positive
outcome to quantitative analysis was ranked fourth in importance in the decision to lease both
land and buildings and other assets (row 4). These findings are somewhat surprising,
considering approximately 30% of respondents had previously acknowledged that they did
not undertake quantitative analysis (Table 2, panel B).
One major difference between the decision to lease land and buildings and the decision to
lease other assets appears to be incentives offered by the lessor, such as rent-free periods or
reverse premiums. This factor was ranked fifth in importance in the decision to lease land and
buildings but ranked twentieth in the decision to lease other assets (row 5). The difference
was also found to be statistically significant between the two. Perhaps incentives are more
readily available and/or more valuable in lease agreements for land and buildings.
Further differences between asset categories emerge in the importance placed on the ability of
leasing to offer a complete package (row 11), and the ease with which leasing can be arranged
from an administrative point of view (row 17). These two factors are more important in the
decision to lease other assets. However, in the case of land and buildings, maintenance
contracts, etc., could just as easily be available on freehold property through appointed
property managers at the time of purchase, as through lease agreements. In relation to
administrative arrangements, a long term property lease, with the exception of additional
finance arrangements required to purchase, could require as close a scrutiny and involve the
same legal checks as a purchase contract. Further, the administration involved could be
considered increasingly insignificant in relation to the acquisition of an asset as significant as
property. The relative importance of other factors in the decision to lease both land and
buildings and other assets are relatively similar. The transfer of capital allowances to the
lessor only applies in the decision to lease other assets and was considered fairly important
(Panel B, row 1). Although reductions in the amount of capital allowances transferred seem
less influential (Panel B, rows 2 & 3).
4.4 The relative importance of factors in the decision not to lease
The relative importance of nine factors in the decision not to lease both land and buildings
and other assets in a particular circumstance are shown in Table 4. In all cases, mean
responses were found to be significantly greater than 1, i.e. not important at all.
[Table 4]
13
The most important factor in the decision not to lease appeared to be the expense involved
compared to other sources of finance (row 1). This was found to be statistically more
important in the decision not to lease other assets compared to land and buildings, which may
reflect the ease with which other assets could be obtained using other sources of finance.
General comments made by respondents provide some indication of this being the case, e.g.,
“the alternative to leasing is not always available” and “the properties we operate from are
only available on lease”. Company preference for legal ownership was ranked second in
importance (row 2). The least important factor in the decision not to lease both land and
buildings and other assets appeared to be the notion that leasing indicates a source of financial
weakness (row 9).
Three factors suggested in the decision not to lease (Table 4) correspond to factors suggested
in the decision to lease (Table 3). To test for consistency in the responses provided, a
comparison was made and correlation coefficients obtained. First, if leasing being more
expensive than other sources of finance was important in the decision not to lease (row 1,
Table 4), the rate of interest implicit in leasing compared to borrowing (row 3, Panel A, Table
3) might be expected to be equally important in the decision to lease. The Spearman
correlation coefficient between the two sets of responses is 0.603 (p<0.001) for land and
buildings and 0.396 (p<0.001) for other assets. Therefore, the importance of the cost of
leasing compared to other sources appears consistent across respondents’ decisions to lease
and not to lease.
Second, if the loss of grants/taxation allowances was important in the decision not to lease
other assets (row 4, Table 4), this might suggest that respondents derive more benefit from
their own use of such allowances. The opposite would be true if transferring capital tax
allowances to the leasing company reflected in lower lease rental cost were important in the
decision to lease other assets (row 1, Panel B, Table 3). The Spearman correlation coefficient
between the two sets of responses is 0.234 (p=0.011). If respondents mostly derived benefit
from either their own use of tax allowances or transferring them to the leasing company, a
negative correlation coefficient might have been expected. However, the positive relationship
might merely reflect that, in some leasing situations, the loss of tax allowances brings no
additional benefit and is, therefore, a deciding factor in the decision not to lease. In other
situations, the benefit derived from transferring the tax allowances could be a deciding factor
in the decision to lease. As more importance appears to be placed on transferring allowances
(mean=3.08) compared to the loss (mean=2.43), leasing appears to offer a net tax advantage
for the respondents as a whole.
14
Third, the repossession of leased assets from lessees in default does not appear to be an
important consideration in the decision not to lease land and buildings and other assets (row 6,
Table 4). This could indicate that respondents either don’t contemplate default or don’t
consider repossession a serious consequence. However, the legal consequence of default
being less severe for leasing also does not appear to be an important consideration in the
decision to lease either land and buildings or other assets (row 19, Panel A, Table 3). The
correlation coefficients between the two sets of responses are 0.406 (p<0.001) for land and
buildings and 0.5000 (p<0.001) for other assets. Therefore, respondents don’t appear to
contemplate default in the leasing decision, in which case the less severe consequences of
leasing don’t appear to be an advantage.
4.5 Lease agreement features
In lease agreements with a contingent element to rental payments, a fixed repayment cost is
converted to one which varies with use, operating performance or market prices. The use of
contingent elements in lease agreements by respondents is shown in Panel A of Table 5. The
most common contingent element appeared to be rentals which vary in line with prices in
respect of leased land and buildings (row 1). However, approximately 41% of respondents
currently engaged in leasing land and buildings indicated this was never or seldom the case.
This is somewhat surprising given that property leases in the UK are typically long-term
leases in which rentals are increased to prevailing market prices at regular intervals. Further,
according to the Finance and Leasing Association, property leases without rent rises are
virtually non-existent in the UK. Although rentals that vary with usage appeared the most
popular contingent element in lease agreements for other assets (row 3), the vast majority
(69% of respondents) indicated that they were never a feature.
[Table 5]
The risks associated with asset disposal at the end of a lease agreement can be appropriated
between lessee and lessor via various residual arrangements. The extent of respondents’
interest in residual value is shown in Panel B of Table 5. The most common form of residual
interest appeared to be the transfer of ownership at the end of lease contracts (row 1), this
being far more commonplace in the leasing of other assets (mean=2.71) compared to land and
buildings (mean=1.58). Receiving a share of the sales proceeds of other leased assets
(mean=2.13) was more common than receiving a share of the sale proceeds of leased land and
buildings (mean=1.44). Giving a guarantee to pay compensation for a residual value below a
certain amount appeared least common in the leasing of both land and buildings and other
assets (mean=1.26 and 1.74 respectively).
15
4.6 Further analysis
Statistical analysis revealed that firm size and level of gearing do not influence the
dichotomous choice between lease use / non-use.6 However, industry classification appears
influential, with firms operating in Information Technology, General Industries and Cyclical
Services more likely to use or consider leasing.7 This may reflect the nature of assets
employed in these industries. Assets employed in Information Technology are subject to rapid
obsolescence, and assets employed in General Industries / Cyclical Services may be more
standardised and thus conducive to being the subject of lease contracts.
Significant differences in the reasons for leasing are apparent across company size (Appendix
2). Small companies appear to place more importance on qualitative factors such as avoiding
large capital outlay, conservation of cash flow, ease of administration, and availability on any
scale. Large companies appear more concerned with quantitative factors – the cost. However,
large companies appear to have a greater preference for legal ownership of land and buildings
compared to small firms. Not surprisingly, highly geared companies appear to be more
concerned with the impact leasing has on restrictive covenants, and also prefer legal
ownership in relation to land and buildings.
The reasons for leasing do not appear constant across firms operating in different industries
(Appendix 3). Utility firms such as those providing water, electricity and gas attach more
importance to avoiding large capital outlay and the cost of leasing. However, firms operating
in these industries compete in terms of costs and are unable to pass substantial costs on to
customers owing to the presence of industry regulators. Firms operating in Non-Cyclical
Services (food & drug retailers and telecommunication services) appear more concerned with
the limited duration of occupancy / control over leased land and buildings. These firms appear
less concerned with the loss of grants / taxation allowances through leasing and avoiding large
capital outlay. Firms operating in Cyclical Services (support services; media & photography;
general retailers; leisure, entertainment and hotels; distributors) and Information Technology
appear to attach less importance to the cost of leasing.
4.7 Survey evidence in relation to theoretical reasons for leasing
The survey evidence in relation to theoretical reasons for leasing is summarised in Table 6. To
aid an evaluation of the relative importance of factors influencing the leasing decision,
responses were classified into five categories based on the strength of evidence obtained. The
strength of evidence related to the percentage of respondents who indicated that a factor was
fairly to very important to them, or that they sometimes to always entered into a lease
16
agreement with a certain feature. Percentages were classified as follows: 0% to 20% strongly unsupported; 21% to 40% - unsupported; 41% to 60% - neutral; 61% to 80% - in
support; 81% to 100% strongly in support.
[Table 6]
The evidence in relation to the impact of accounting treatment on the leasing decision was
neutral (Panel A). Tax considerations still exert some influence over the leasing decision
(Panel B). Respondents lease land and buildings because the lease rentals are a tax-deductible
expense, when the asset itself does not qualify for capital tax allowances. Respondents also
claim that other assets are leased because the ability to transfer capital tax allowances to the
lessor is reflected in lower lease rental payments. Time apportionment of qualifying
expenditure under finance leases in first year, and the restriction of writing down allowances
to 6% on qualifying expenditure on long-life assets, did not influence the leasing decision.
Leasing is not used with the intention of expanding overall debt type capacity (Panel C). The
evidence in relation to lease covenants being less restrictive was neutral. In relation to
repayment reasons (Panel D), avoiding large capital outlay and conservation of cash flow
were most influential in the decision to lease both land and buildings and other assets.
However, repayment flexibility does not feature. The provision of 100% finance is important
in the decision to lease other assets.
The flexibility to shift the risks and rewards between parties to a lease agreement does not
feature significantly in the decision to lease (Panel E). Respondents did not attach any
importance to risk-sharing reasons for leasing and lease agreements with risk-sharing features
were not widely employed by respondents. However, with the exception of operating leased
land and buildings with rentals that vary in line with prices, the features investigated may be
more commonly employed in finance lease agreements. As respondents predominantly use
operating leases, the lack of use of such risk-sharing features may not be surprising. These
findings contrast with a prior US survey which found the avoidance of obsolescence risk to be
the most important advantage to leasing (Mukherjee, 1991).
The cost of leasing in relation to other sources is important in the leasing decision (Panel F). It
appears more important when deciding to lease other assets than in the decision to lease land
and buildings. However, cost may not be the deciding factor to lease land and buildings if
access to a particular property is not available by any other means. Incentives given by the
lessor in terms of rent-free periods are influential in the decision to lease land and buildings,
but not in relation to other assets. The opportunity to obtain finance on any scale appears
17
important in the decision to lease other assets. Practical considerations such as administrative
arrangements and availability at point of sale are not of particular importance. The avoidance
of capital expenditure controls plays no part whatsoever in the decision to lease.
4.8 Importance of current accounting and tax treatments
If accounting and / or tax treatments currently provide incentives to use operating leases, the
role of leasing can be expected to change in response to accounting and tax reform. The
evidence for the entire sample of respondents was neutral in relation to the impact of the
current lease accounting treatment. However, 27 companies (approximately 14%) indicated
that the ‘off-balance’ sheet nature of operating leases with no impact on financial accounting
ratios was very important / important in the decision to lease land and buildings. Further, 32
companies (approximately 16%) indicated it was very important / important in the decision to
lease other assets. For these companies, the ‘off-balance’ sheet nature of operating leases was
considered the most important factor in the leasing decision, and significantly more important
than any other factor.8 To explore this finding, the characteristics of these companies were
examined and found to represent a wide range of size and financial gearing levels. They also
operated across a wide range of industries, although high lease industries such as Information
Technology, General industries and Cyclical Services were significantly represented.
For the entire sample, there was supporting evidence in relation to the importance attached to
the award of capital tax allowances to the lessor in the decision to lease other assets. Fifty
companies (approximately 26%) indicated it was very important / important. For these
companies, it was considered the most important factor in the leasing decision (mean response
of 4.14), and significantly more important than any other factor (mean response of 3.6 in
response to the importance attached to the interest rate implicit in the lease). These companies
also represented a wide range of size and gearing levels and industry classifications. In total,
13 companies (approximately 7%) considered both the current accounting and tax treatments
to be very important / important in the decision to lease.
5. Summary and conclusions
This paper uses a questionnaire survey of 198 UK finance directors to investigate the relative
importance of financial and non-financial factors in the decision to lease. Avoiding large
capital outlay and cash flow considerations appear of paramount importance in the decision to
lease all asset types. Other advantages to leasing in comparison to other sources of finance
include: tax benefits, availability to finance on any scale and the opportunity to obtain service
and maintenance packages. The importance attached to these advantages is likely to depend
18
on individual circumstances, and is not consistent across firm size. Small firms appear more
concerned with qualitative factors such as avoiding large capital outlay, conservation of cash
flow and availability on any scale. Large firms appear more concerned with cost. Although
Drury and Braund (1990), the most recent prior UK survey, found cost to dominate the
leasing decision for large firms, they documented a lack of importance of other qualitative
and cash flow considerations to large firms which was not apparent in the present study.
However, Drury and Braund’s study was conducted over a decade earlier when finance leases
were predominant. Also, they did not consider the relative importance of factors in the
decision to lease alternative asset types.
Across all respondents, the evidence was neutral in relation to the importance attached to the
‘off-balance sheet’ accounting treatment of operating leases. However, for a significant subgroup of companies, it was found to be the most important factor in the decision to lease.
Supporting evidence was obtained in relation to the importance attached to the award of
capital tax allowances to the lessor. For over a quarter of responding companies it was found
to be very important / important in the decision to lease other assets. These findings contradict
previous US survey findings which document the insignificance of ‘off-balance sheet’ and tax
advantages to leasing (Mukherjee, 1991). In the UK, Drury and Braund (1990) suggested that
tax considerations dominate the leasing decision for large firms. The present study indicates
that the importance attached to the award of capital allowances to the lessor is not a function
of company size.
This paper contributes to the understanding of lease financing by providing comprehensive
up-to-date evidence of leasing decisions across UK listed industrial companies. It provides
policy-relevant ex ante evidence in support of the standard setting process by providing an
indication of the potential consequences of intended changes to the lease accounting and tax
regulations. It follows from the importance attached to ‘off-balance sheet’ accounting
treatment by some companies that bringing operating leases ‘on-balance sheet’ may influence
their leasing decision. The importance attached to the award of capital allowances to the
lessor indicates that corporation tax reform has the potential to significantly influence leasing
activity. Given that accounting and tax treatments are important for a wide range of
companies in terms of size, gearing and industry classification, the extent to which proposed
changes will influence leasing activity is difficult to predict. However, given the importance
attached to reasons other than accounting and taxation, the popularity of leasing as a source of
finance is set to continue.
19
Notes
1
Ang and Peterson (1984); Bathala and Mukherjee (1995); Sharpe and Nguyen (1995),
Graham, Lemmon and Schallheim (1998); Mehran, Taggart and Yermack (1999); Duke,
Franz, Hunt and Toy (1999); Adedeji and Stapleton (1996); Beattie, Goodacre and Thomson
(2000).
2
A questionnaire investigating lease accounting reform was sent out over a similar time
period to the remaining third of the UKQI population. Respondents to this survey were
invited to request the ‘leasing and corporate financing decisions‘ questionnaire and 6
requested and completed the questionnaire.
3
In earlier leasing surveys addressed to UK quoted companies, Taylor and Turley also
obtained 198 responses (response rate 39.6%) over 1982 to 1983, and Drury and Braund
(1990) obtained 273 responses (response rate 28%). In relation to prior capital structure
surveys in the US of the Fortune 500/1000 firms, a notable decrease in response rate can be
observed over time. For example, Scott and Johnson (1982) achieved 39.6% and Pinegar and
Wilbricht (1989) achieved 35.2% compared to 12% by Trahan and Gitman (1995), 8.5% by
Graham and Harvey (2001) and 12.7% by Bancel and Mittoo (1994). The response rate to this
questionnaire is high relative to Graham and Harvey’s latest US capital structure survey and
Bancel and Mittoo’s survey on convertible debt issue across European firms.
4
The use of operating leases was selected on the basis that previous research has documented
their significant and widespread use (Beattie, Edwards and Goodacre, 1998). Obtaining a
combination of both finance and operating lease use would require the collection of a
significant amount of data in order to follow an operating lease capitalisation process.
5
Measures of both total assets and sales were used to proxy firm size. Measures of both total
gearing and long-term gearing were used. Total gearing was represented by the ratio of total
loan capital plus borrowings repayable in less than one year to the value of equity.
Borrowings repayable in less than one year were excluded from the long-term gearing
measure. Datastream’s level 3 industry classifications were used.
6
For both large and small companies (size proxied by assets), 83% of respondents used, had
used or would consider using leasing (chi-square = 0.002, p=0.969). In terms of total gearing,
86% of high geared and 78% of low geared respondents used, had used or would consider
20
using leasing (chi-square = 1.622, p=0.203). Similar percentages were found when sales were
used as a proxy for size and long-term gearing measure used.
7
Percentage of respondents indicating that they used, had used or would consider using
leasing: 94% in Information Technology, 88% in General Industries, 90% in Cyclical
Services, 78% in Basic Industries, 78% in Non-Cyclical Consumer Goods, 71% in others the remaining four groups containing a small number of companies were combined(chisquare = 9.796, p=0.081).
8
The mean response in relation to the importance attached to the ‘off-balance’ sheet nature of
operating leases in the decision to lease land and buildings was 4.39 compared to a mean
response of 3.9 for the second most important factor, avoiding large capital outlay. For the
decision to lease other assets the mean response was 4.31 compared to 3.67 for the second
most important factor, conservation of cash flow.
Acknowledgements
This research was conducted as part of a PhD project. The guidance provided by
supervisors Professor Vivien Beattie (University of Glasgow) and Professor Alan
Goodacre (University of Stirling) is greatly appreciated. The financial support of The
Carnegie Trust for the Universities of Scotland in the form of a scholarship and the
contribution made by the finance directors who gave so freely of their time in
completing the questionnaire survey are also gratefully acknowledged. Comments
made by Professor Vivien Beattie are very much appreciated.
21
References
Adedeji, A. and Stapleton, R.C., ‘Leases, debt and taxable capacity’, Applied Financial
Economics, Vol. 6,1996, pp. 71-83.
Ang, J. and Peterson, P.P., ‘The leasing puzzle’, Journal of Finance, Vol. 39(4), 1984, pp.
1055-1065.
ASB, Leases: Implementation of a New Approach, Discussion Paper (London 1999:
Accounting Standards Board)
ASC, Accounting for Leases and Hire Purchase Contracts, Statement of Standard Accounting
Practice No. 21 (London 1984: Accounting Standards Committee)
Bancel, F. and Mittoo, U.R., ‘Why do European firms issue convertible debt?’, European
Financial Management, Vol. 10(2), 2004, pp. 339-374.
Barclay, M.J. and Smith, C.W., ‘The priority structure of corporate liabilities’, Journal of
Finance, Vol. 50(3), July, 1995, pp. 899-917.
Bathala, C.T. and Mukherjee, T.K, ‘A survey of leasing in small firms’, The Journal of Small
Business Finance, Vol. 4(2/3),1995, pp. 113-127.
Beattie, V.A., Edwards, K. and Goodacre, A., ‘The impact of constructive operating lease
capitalisation on key accounting ratios’, Accounting and Business Research, Vol.
28(4), 1998, Autumn, pp. 233-254.
Beattie, V.A., Goodacre, A. and Thomson, S., ‘Operating leases and the assessment of leasedebt substitutability’, Journal of Banking and Finance, Vol. 24, 2000, pp. 427-470.
Beattie, V.A., Goodacre, A. and Thomson, S.J., Leasing: its Financing Role and Accounting
Treatment (London 2004: Institute of Chartered Accountants in England and Wales).
Belkaoui, A, Long term leasing – accounting, evaluation, consequences, Quorum Books,
1998.
Day, A., The finance director’s guide to purchase leasing, Financial Times Prentice Hall,
2000.
Drury, C. and Braund, S., ‘The leasing decision: A comparison of theory and practice’,
Accounting and Business Research, Vol. 20(79), 1990, pp. 179-191.
Duke, J.C., Franz, D.P., Hunt, H.G. and Toy, D.R., ‘Firm-specific determinants of off-balance
sheet leasing: A test of the Smith/Wakeman model’, conference paper, Annual
American Accounting Association Meeting, August 1999.
Fawthrop, R.A. and Terry, B., ‘Debt management and the use of leasing finance in UK
corporate financing strategies, Journal of Business Finance and Accounting, Vol.
2(3), Autumn, 1975, pp. 295-314.
Graham, J.R. and Harvey, C.R., ‘The theory and practice of corporate finance: evidence from
the field’, Journal of Financial Economics, Vol. 60(2/3), May, 2001, pp. 187-243.
Graham, J.R., Lemmon, M.L., and Schallheim, J.S., ‘Debt, leases, taxes and the endogeneity of
corporate tax status’, Journal of Finance, Vol. 53, 1998, pp. 131-162.
22
HMSO, Corporation Tax Reform, Consultation document, August 2003, Her Majesty’s
Stationery Office.
Hull, J.C. and Hubbard, G.L., ‘Lease evaluation in the UK: current theory and practice’,
Journal of Business Finance and Accounting, Vol. 7, 1980, pp. 619-637.
Kare, D.D. and Herbst, A.F., ‘The influence of profitability on a firm’s lease-or-borrow
decision’, Advances in Accounting, Vol. 8, 1990, pp. 25-36.
Krishnan, V.S. and Moyer, R.C., ‘Bankruptcy costs and financial leasing decision’, Financial
Management, Vol. 23(2), 1994, pp. 31-42.
Lasfer, M.A. and Levis, M., ‘The determinants of the leasing decision of small and large
companies’, European Financial Management, Vol. 4(2), 1998, pp. 159-184.
Leaseurope,
‘Leasing
activity
in
Europe
–
Key
facts
and
figures
2003’,
www.leaseurope.org/pages/statistics/stat.asp
Loveday, G., ‘Leasing’, Financial reporting 1994-95: A survey of UK reporting practice,
[Eds: Tonkin, D. J. and L. C. L. Skerratt], ICAEW, Milton Keynes, 1994, pp. 15-28.
Mayes, D.G. and Nicholas, C.S., The economic impact of leasing, Basingstoke: Macmillan,
1988.
Mehran, H., Taggart, R.A., and Yermack, D., ‘CEO ownership, leasing and debt financing’,
Financial Management, Vol. 28(2), 1999, pp. 5-15.
Mukerjee, T.K., ‘A survey of corporate leasing analysis’, Financial Management, Vol. 20(3),
1991, pp. 96-107.
O’Brien, T.J. and Nunnally, B.H., ‘A 1982 survey of corporate leasing analysis’, Financial
Management, Summer, 1983, pp.30-36.
Oppenheim, A.N., Questionnaire design and attitude measurement, Heinemann, 1966.
Pinegar, J.M. and Wilbricht, L., ‘What managers think of capital structure: a survey’,
Financial Management, Vol. 18(4), Winter, 1989, pp.82-91.
Schallheim, J.S., Lease or Buy? Principles for sound decision making, Harvard Business
School Press Boston, Massachusetts, 1994.
Schipper, K., ‘Academic accounting research and the standard setting process’, Accounting
Horizons, Vol. 8(4), 1994, pp. 61-73.
Scott, D.F. and Johnson, D.J., ‘Financing policies and practices in large corporations’,
Financial Management, Vol. 11(2), Summer, 1982, pp. 51-59.
Sharpe, S.A. and Nguyen, N.H., ‘Capital market imperfections and the incentive to lease’,
Journal of Financial Economics, Vol. 39, 1995, pp. 271-294.
Smith, C.W. and Wakeman, L.M., ‘Determinants of corporate leasing policy’, Journal of
Finance, Vol. 40(3), 1985, pp. 895-908.
23
Stulz, R.M. and Johnson, H., ‘An analysis of secured debt’, Journal of Financial Economics,
Vol. 14, 1985, pp. 501-521.
Sykes, A., The lease-buy decision – A survey of current practices in 202 companies,
Management survey report No. 29, 1976, British Institute of Management.
Taylor, P. and Turley, S., ‘The views of management on accounting for leases’, Accounting
and Business Research, Vol. 16, Winter, 1985, pp. 59-67.
Tomkins, C.R., Lowe, J.F. and Morgan, E.J., An economic analysis of the financial leasing
industry, Saxon House, 1979.
Trahan, E.A. and Gitman, L.J., ‘Bridging the theory-practice gap in corporate finance: a
survey of chief financial officers’, Quarterly Review of Economics and Finance, Vol.
35(1), Spring, 1995, pp. 73-87.
Tweedie, D. and Whittington, G., ‘Financial reporting: current problems and their
implications for systematic reform’, Accountancy and Business Research, Vol.
21(81), 1990, pp.87-102.
24
Table 1: Use of leasing
% of Respondents (n=196)
Asset Category:
Land and
Plant and
Office
Computer
Vehicles
Buildings
Machinery
Equipment
Equipment
Finance leases
12%
35%
15%
18%
23%
Operating leases
37%
23%
24%
20%
38%
Finance leases
11%
32%
14%
22%
23%
Operating leases
43%
26%
29%
23%
49%
Finance leases
16%
32%
17%
19%
20%
Operating leases
33%
27%
23%
24%
38%
Last 2-3 years
Currently
Would consider
Note:
Respondents were asked to tick all applicable options
25
Table 2: General approach to leasing decision
Panel A: Use of quantitative analysis
Question asked (abbreviated)
% of Respondents (n=156)
In making a leasing decision which best describes your
company’s actions:
1
Quantitatively analyse a leasing alternative only if asset
would have been profitable on purchase basis
51%
2
Quantitatively analyse potential of leasing asset even if
asset purchase would not be considered profitable
18%
3
Do not perform any type of quantitative analysis because
simply prefer to lease some asset types
15%
4
Do not perform any type of quantitative analysis but rely on
judgement and experience
15%
Panel B: How leasing fits in with overall company financing decisions
Tick all applicable options
% of Respondents
(n=196)
1
Leasing decisions taken centrally
52%
2
Leasing policies are set centrally
44%
3
Only specific assets leased
35%
4
Take advantage of good leasing deals if/when they arise
35%
5
Leasing alternative considered in all asset financing decisions
23%
6
Use leasing to solve specific financing problems
23%
7
Do not have general leasing policies
14%
8
Generally, prefer to lease whenever possible
8%
9
Target proportion of assets to be financed by leasing
3%
Panel C: Comparison between leasing and other sources of finance
Question asked (abbreviated)
% of Respondents (n=196)
With which alternative sources of finance is leasing
compared (tick all that apply)
1
Bank borrowing
53%
2
Internal profit (retained profit)
35%
3
Hire purchase
30%
4
All forms of debt rather than a specific type
21%
5
No comparison made
5%
26
Table 3: Relative importance of factors in the decision to lease
Panel A Factors in the decision to lease both land & buildings and other assets
Mean1,2
(Standard deviation)
L&B
rank
Question asked (abbreviated)
Please indicate the relative importance of the following
factors in your company’s decision to leases land and
buildings and other asset
1
Avoiding large capital outlay
2
Conservation of cash flow
3
Rate of interest implicit in lease
4
Positive outcome of quantitative analysis
5
Incentives to lease given by lessor
6
Lease rentals are tax deductible but capital allowances
not available on asset purchased
7
Leasing can be obtained on any scale
8
Leasing permits the total financing of an asset (apart
from advanced rental deposit)
9
Lease covenants generally less restrictive
10
Operating leases are not accounted for on the balance
sheet and have no impact on financial accounting ratios
11
Leasing has the ability to offer a complete package
12
Expanding overall debt-type capacity
13
Leasing has minimal impact on measures used in
current debt covenants
14
Leasing can reduce/eliminate risk of ownership
15
Lease agreements flexible, sharing asset risk and
economic benefit between parties as required
16
Leasing is conveniently offered at point of sale
17
Leasing is easier from an administrative point of view
18
Higher disposal value of leased property
19
Legal consequences of default less severe for leasing
20
Contingent lease rentals can reduce company exposure
to economic or business downturns
21
Flexible repayment – low lease rentals early on
22
Operating leases avoid capital expenditure controls
27
Land
&
Build
Other
Assets
Other
Assets
rank3
Diff4
3.68
(1.12)
3.51
(1.13)
3.42
(1.06)
3.14
(1.21)
3.04
(1.18)
2.92
(1.13)
3.39
(1.11)
3.57
(1.00)
3.60
(0.96)
3.18
(1.24)
2.27
(1.15)
2.83
(1.10)
3
0.29
2
ns
1
ns
4
ns
20
0.77
9
ns
2.82
(1.24)
2.70
(1.19)
3.08
(1.19)
2.97
(1.15)
6
ns
8
ns
2.59
(1.11)
2.58
(1.26)
2.47
(1.16)
2.64
(1.23)
14
ns
10
ns
2.55
(1.17)
2.40
(1.13)
2.36
(1.04)
3.11
(1.20)
2.42
(1.13)
2.34
(1.02)
5
-0.56
16
ns
18
ns
2.31
(1.02)
2.30
(1.06)
2.51
(1.02)
2.51
(1.07)
11
ns
12
ns
2.19
(1.20)
2.18
(1.01)
2.13
(0.98)
2.07
(1.02)
2.05
(1.01)
2.42
(1.24)
2.47
(1.14)
2.27
(1.01)
2.11
(0.99)
2.01
(0.93)
17
ns
13
-0.29
21
ns
23
ns
24
ns
1.95
(0.94)
1.57
(0.78)
2.12
(1.05)
1.64
(0.89)
22
ns
25
ns
Panel B Factors specific to the decision to lease other assets
Mean1,2
(Standard deviation)
Question asked (abbreviated)
Other Assets
Other Assets
rank3
Please indicate the relative importance of the following
factors in your company’s decision to lease other assets
1
Transfer of capital tax allowances to leasing company
reflected in lower lease rental cost
3.08
(1.05)
7
2
Expenditure under finance leasing, qualifying for capital tax
allowances is time apportioned in first year
2.47
(1.01)
15
3
Expenditure on long-life assets qualifying for capital tax
allowances is restricted to a WDA of 6%
2.29
(0.93)
19
Notes:
1. Response categories are: 1 = not important at all, 2 = of little importance, 3 = fairly important,
4 = important, 5 = very important
2. All mean responses significantly different from not important at all (i.e.1) at 1% level (one-tailed
test)
3. Ranked by mean responses for land and buildings; Other assets rank = rank of mean responses for
other assets
4. P-Value from a Wilcoxon-Mann-Whitney test for significant difference between medians:
significant differences of 5% and above are reported (2-tail test); ns = not significant
28
Table 4: Relative importance of factors in the decision not to lease
Mean1,2
(Standard deviation)
Question asked (abbreviated)
Please indicate the relative importance of the following
factors in your company’s decision not to lease land
and buildings and other assets
Land
&
Build
Other
Assets
Diff4
1
Leasing is more expensive than other sources of
finance
3.36
(1.27)
3.68
(1.10)
-0.32
2
Company preference for legal ownership
Control over and hence the ability to use leased
property is limited to duration of lease agreement with
extension at lessor’s discretion
2.77
(1.29)
2.58
(1.14)
ns
3
2.98
(1.37)
2.77
(1.20)
4
Loss of grants / taxation allowances if an asset is leased
Company assets are highly specialised or company
specific, making it expensive for a lessor to bear the
risk of obsolescence and the costs of purchase and
disposal
2.43
(1.09)
2.37
(1.29)
ns
5
2.32
(1.08)
2.11
(1.18)
6
Assets acquired under lease agreement can be
repossessed if company defaults
1.87
(0.92)
1.89
(0.90)
ns
7
Some key company executives are opposed to leasing
Leasing does not provide 100% finance due to the
requirement of advance rentals
1.80
(1.05)
1.68
(0.72)
ns
8
1.71
(0.97)
1.70
(0.76)
9
Leasing indicates a source of financial weakness
1.58
(0.73)
1.62
(0.77)
ns
Notes: See Table 3
29
ns
ns
ns
Table 5: Lease agreement features
Panel A: The use of contingent rentals
Mean1,2
(Standard deviation)
Question asked (abbreviated)
To what extent does your company enter lease
agreements in which rentals vary with:
1
Prices (upward-only rent reviews)
2
Revenue / profits derived from use of leased asset
3
Usage
Land
&
Build
Other
Assets
2.44
(1.42)
1.26
(0.65)
1.13
(0.43)
1.39
(0.84)
1.21
(0.62)
1.66
(1.08)
Panel B: Lessee interest in residual value
Mean1,2
(Standard deviation)
Question asked (abbreviated)
To what extent does your company enter lease
agreements in which:
Land
&
Build
Other
Assets
1
Ownership is transferred to lessee at the end of the
agreement
1.58
(1.14)
2.71
(1.26)
2
All or a share of the proceeds is received by lessee on
the sale of the leased asset
1.44
(0.95)
2.13
(1.23)
3
A surplus is received by lessee if the residual value is
above a certain amount
1.36
(0.78)
1.96
(1.07)
4
A guarantee is given by lessee to pay compensation if
the residual value is below a certain amount
1.26
(0.67)
1.74
(0.98)
Notes:
1. Response categories are: 1 = never, 2 = seldom, 3 = sometimes, 4 = usually, 5 = always
2. All mean responses significantly different from never (i.e., 1) at 1% level (one-tailed test)
30
Table 6: Summary of survey evidence on factors influencing the leasing decision
Panel A: Accounting treatment
Strength of Evidence1
Importance of factors influencing the leasing decision
Land and Buildings
SU
U
N
Operating leases are not on the balance sheet and have no
impact on financial accounting ratios
S
Other Assets
SS
SU
U
N
b
b
Land and Buildings
Other Assets
S
SS
S
SS
Panel B: Tax saving reasons
Importance of factors influencing the leasing decision
SU
U
N
Lease rentals tax deductible but capital allowances not
allowances not available on assets purchased
S
b
SS
SU
U
b
b
Loss of grants / tax allowances if asset is leased
N
b
Transfer of capital allowances to lessor reflected in lower
lease rental cost
b
Time apportionment of qualifying expenditure under
finance leases in first year
b
N/A
Restriction to 6% WDA on qualifying expenditure on longlife assets
b
31
Panel C: Borrowing capacity
Land and Buildings
Importance of factors influencing the leasing decision
SU
U
N
S
Other Assets
SS
SU
b
Expanding overall debt-type capacity
U
N
S
SS
S
SS
b
Lease covenants generally less restrictive
b
b
Leasing has minimal impact on measures used in current
debt covenants
b
b
Land and Buildings
Other Assets
Panel D: Repayment
Importance of factors influencing the leasing decision
SU
U
N
SU
U
N
b
b
Leasing provides total finance for an asset
b
b
b
b
Conservation of cash flow
Flexibility of lease repayments
SS
b
Avoiding large capital outlay
Leasing does not provide 100% finance
S
b
b
b
32
Panel E: Risk sharing reasons
Land and Buildings
Importance of factors influencing the leasing decision
SU
U
N
S
Other Assets
SS
SU
U
N
Leasing can reduce / eliminate risk of significant cost of
transferring ownership at end of a contract
b
b
Higher disposal value of leased property – lessor has better
access to / knowledge of markets
b
b
Lease rentals contingent on sales / profits can reduce
exposure to economic / business downturns
b
b
Lease agreements are flexible – drawn up to share asset risk
and economic benefits between parties
b
Company assets specialised / specific making it expensive
for lessor to bear risks of obsolescence and costs of
purchase / disposal
Use of lease agreements with rentals that vary with:
Usage
Revenue / Profits
b
b
b
b
b
b
b
b
Prices
Use of lease agreements with residual interest:
ownership transferred when contract ends
b
Lessee guarantees residual value, lessee benefits from high
residual value, all or share of sales proceeds received by
lessee
b
S
b
b
b
33
SS
Panel F: Other reasons
Importance of factors influencing the leasing decision
Land and Buildings
SU
U
N
S
SS
SU
U
b
Leasing is easier to arrange on an administrative basis
N
b
SS
b
b
Leasing is conveniently offered at asset point of sale
S
b
Leasing has the ability to offer a complete package
(including service and maintenance agreements)
b
Rate of interest in lease compared to borrowing
b
Incentives to lease given by lessor
b
Leasing is more expensive in decision not to lease
b
Leasing avoids capital expenditure controls
Other Assets
b
b
b
b
b
b
Leasing provides finance on any scale
b
Notes:
1
Strength of evidence based on percentage of respondents who indicated they took a particular action, indicated something was fairly to very important, or
agreed or strongly agreed with something, classified as follows:0-20% = SU (strongly unsupported), 21-40% = U (unsupported), 41-60% = N (neutral), 61-80% = S (supported), 81-100% = SS (strongly supported).
34
Appendix 1: Descriptive statistics: Company size, gearing and industry
Size by assets (£’m)
Panel A: Company size
Size by sales (£’m)
Mean
Stan Dev
Min
Max
Mean
Stan Dev
Min
Max
Total sample (n = 198)
871.7
2426.9
701
17288
840.
2384.8
0.00
17158
Small (n=66)
10.8
7.9
701
27.6
9.3
7.8
0.00
27.7
Large (n=66)
2532.1
3694.3
14227
17288
2422.5
3663.1
204.8
17158
Total Gearing2
Panel B: Gearing
Long-term Gearing2
Mean
Stan Dev
Min
Max
Mean
Stan Dev
Min
Max
Total sample (n = 196)
0.43
0.71
0.00
6.19
0.24
0.37
0.00
2.56
High gearing firms (n=65)
1.07
0.92
0.41
6.19
0.60
0.47
0.24
2.56
Low gearing firms (n=66)
0.03
0.03
0.00
0.08
0.01
0.01
0.00
0.02
Panel C: Industry classification
BI1
CCG1
CS1
GI1
IT1
NCCG1
NCS1
R1
U1
(n = 19)
(n = 15)
(n = 72)
(n = 18)
(n = 18)
(n = 32)
(n = 6)
(n = 13)
(n = 5)
9.60%
7.58%
36.36%
9.09%
9.09%
16.16%
3.03%
6.57%
2.53%
1
Notes: Datastream level 3 industry classifications: BI = Basic Industries; CCG = Cyclical Consumer Goods; CS = Cyclical services; GI = General Industries; IT =
Information Technology; NCCG = Non-Cyclical Consumer Goods; NCS = Non-Cyclical Services; R = Resources; and U = Utilities.
2
Total Gearing = (total loan capital + borrowings repayable in less than one year) / market value of equity; Long-term Gearing = total loan capital / market value of equity
35
Appendix 2: Significant differences in the leasing decision based on size and gearing
Size by sales1
Panel A Relative importance of factors in decision to lease
land and buildings and other assets
Land and Buildings
2
Total Gearing1
Other Assets
Land and Buildings
2
Large
Small
Diff
Large
Small
Diff
3.08
3.70
-0.62
1
Avoiding large capital outlay
3.32
4.09
-0.77
2
Positive outcome to quantitative analysis
3.35
2.79
0.56
3
Leasing is easier to arrange from an administrative
point of view
1.88
2.35
-0.46
2.04
2.77
-0.73
4
Leasing permits total financing
2.39
3.16
-0.77
2.62
3.36
-0.75
5
Operating leases avoid capital expenditure controls
1.34
1.68
-0.34
1.36
1.80
-0.44
6
Conservation of cash flow
2.98
3.84
-0.87
2.92
3.87
-0.96
7
Legal consequences of default less severe for leasing
1.80
2.29
-0.49
1.88
2.38
-0.50
8
Leasing can be obtained on any scale
2.48
3.05
-0.57
2.79
3.40
-0.61
9
Rate of interest implicit in lease compared to cost of
borrowing to purchase
3.84
3.38
0.46
10
Leasing can reduce/eliminate risk of significant cost of
transferring ownership
2.22
2.71
-0.49
11
Leasing is conveniently offered at asset point of sale
2.37
2.80
-0.53
12
Leasing has minimal impact on measures used in
current debt covenants
13
Higher disposal value of leased asset
36
2
Other Assets
High
Low
Diff
High
Low
Diff2
2.4
2.90
-.050
2.79
3.26
-0.46
2.53
2.03
0.50
2.55
2.00
0.55
2.14
2.57
-.043
Appendix 2: Significant differences in the leasing decision based on size and gearing
Size by sales1
Total Gearing1
Panel B Relative importance of factors in decision not to
lease land and buildings and other assets
Land and Buildings
Large
Small
Diff2
Other Assets
Large
Small
Diff2
Land and Buildings
High
Low
Diff2
1
Leasing is more expensive than other sources of
finance
3.83
2.90
0.93
2
Company preference for legal ownership
3.19
2.50
0.69
3.31
2.65
0.66
3
Some key executives are opposed to leasing
1.94
1.42
0.52
1.96
1.40
0.56
4
Loss of grants / taxation allowances if asset is leased
2.65
2.06
0.59
5
Assets acquired under lease agreements can be
repossessed if company defaults
1.60
2.08
-0.47
6
Control over and hence ability to use leased property is
limited with extension at lessor’s discretion
3.00
2.44
0.57
1.63
2.17
Notes:
Mean responses reported
1
Similar differences established using total assets as proxy for company size and long-term gearing measures
2
Differences are significant at 5% level 2-tailed test (Mann-Whitney confidence interval and test Minitab)
37
-0.54
Other Assets
High
Low
Diff2
Appendix 3: Significant differences in the leasing decision based on industry classification
Panel A Relative importance of factors in
decision to lease land and buildings
BI1
CCG1
CS1
GI1
IT1
NCCG1
NCS1
R1
U1
KruskalWallis Test2
1
Avoiding large capital outlay
2.73
(1.27)
3.50
(1.23)
3.84
(1.16)
3.80
(0.86)
3.81
(0.54)
3.91
(0.97)
2.20
(0.84)
3.60
(1.67)
4.00
(1.00)
H = 17.98
p = 0.012**
2
Rate of interest implicit in lease compared to
cost of borrowing to purchase
4.09
(0.70)
3.80
(1.30)
3.09
(1.01)
3.40
(0.99)
3.13
(1.13)
3.68
(0.89)
4.00
(1.73)
3.80
(1.10)
4.33
(0.58)
H= 18.68
p=
0.009***
BI1
CCG1
CS1
GI1
IT1
NCCG1
NCS1
R1
U1
KruskalWallis Test2
Panel B Relative importance of factors in
decision not to lease land and buildings
1
Control over & hence ability to use leased
property is limited with extension at lessor’s
discretion
2.46
(1.13)
3.70
(1.34)
2.58
(1.18)
3.13
(1.09)
2.29
(1.14)
2.78
(1.05)
3.83
(1.47)
3.00
(1.12)
1.67
(0.58)
H = 16.59
p = 0.020**
2
Loss of grants / taxation allowances if asset is
leased
3.07
(0.96)
2.56
(1.01)
2.21
(1.11)
2.29
(0.83)
2.00
(1.10)
2.32
(1.11)
1.50
(0.84)
2.38
(0.92)
3.00
(1.73)
H = 14.36
p = 0.045**
BI1
CCG1
CS1
GI1
IT1
NCCG1
NCS1
R1
U1
KruskalWallis Test2
3.08
(1.44)
1.83
(0.94)
1.95
(1.11)
2.80
(1.21)
2.29
(1.33)
2.41
(1.28)
2.00
(1.10)
4.22
(0.97)
2.67
(0.58)
H = 27.31
p =0.000***
Panel C Relative importance of factors in
decision not to lease other assets
1
Company assets are highly specialised/specific,
making it expensive for a lessor to bear the risk
of obsolescence & costs of purchase & disposal
Notes: 1Datastream level 3 industry classifications: BI = Basic Industries; CS = Cyclical services; GI = General Industries; IT = Information Technology; NCCG = NonCyclical Consumer Goods; OTHERS = Non-Cyclical Services, Resources, Utilities & Cyclical Consumer Goods.
2
*** = significant at 1%, ** = significant at 5%
38