Does the Master’s Eye Fatten the Cattle? Maintenance and Care of Collateral under Purchase and Leasing Contracts

Anna Maria Menichini and Maria Romano

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: The paper presents a theory of leasing in which asset use and maintenance shape the firm’s decision between purchasing or leasing productive assets. When the asset purchase is financed through a secured debt contract and the value of the asset is sensitive to the user’s uncontractible maintenance decision, maintenance may be privately unprofitable for the user and cause asset depletion. This jeopardises the return to the financiers and erodes the benefit of collateral pledging, particularly relevant for financially constrained firms. Such a shortcoming can be overcome with a leasing contract that delegates the maintenance to the lessor. However, delegation generates a novel agency problem on the lessee, who, by not paying for maintenance, may practice inefficiently low levels of care and asset abuse that increase the expected cost of maintenance for the lessor. The paper characterises circumstances in which it may be optimal to lease rather than buy, finding that the reliance on leasing may be non-monotone in financing constraints.

Keywords: Collateral; Financial constraints; Leasing; Maintenance. (search for similar items in EconPapers)
JEL-codes: D82 G32 (search for similar items in EconPapers)
Date: 2018-12-28, Revised 2021-03-15
New Economics Papers: this item is included in nep-bec and nep-cta
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