The Determinants of the Leasing Decision of Small and Large Companies M. Ameziane Lasfer and Mario Levis* City University Business School, Barbican Centre, London EC2Y 8HB, UK. email:
[email protected], and
[email protected].
Abstract We analyse the leasing decision of more than 3000 UK quoted and unquoted companies over the sample period 1982-1996. We show that, for the sample as a whole, companies that use leasing are more likely to have tax losses, high fixed capital investment, high debt-to-equity ratio and to be larger than companies that do not use leasing. We show, however, that the determinants of leasing are not homogeneous across firms of different size. For large companies, leasing, profitability, leverage and taxation are positively correlated. In contrast, for small companies, the leasing decision is not driven by taxation or by profitability, but by growth opportunities. We show that small firms with high Tobin’s q and those that are less profitable are more likely to use leasing.
Keywords: leasing, debt finance, taxation, growth opportunities, small firms. JEL classification: G32
*
We would like to thank Martin Hall and Andy Thompson from the Finance Lease Association for the useful comments and the financial support for this study. Our thanks also to seminar participants at Hull University, City University Business School and Economics Department, and participants at the 6th European Financial Management Association meetings in Istanbul for helpful comments. Responsibility for any errors and omissions rests, obviously, with the authors.
1.
Introduction
Leases take several different forms, the most important of which are sale and leaseback, operating leases and straight financial or capital leases. While these types of leasing differ in their legal, tax and accounting treatments, they are all viewed, in the theory of finance, as part of the financing decisions of the firm. The economic benefits of leasing can be derived from the firm's choice of leasing relative to borrowing and acquiring the asset. The essence of leasing is reflected in the proposition that leasing provides customised financing with potentially unique tax features. Unlike borrowing, the ownership of the asset remains with the lessor and the lessor can deduct tax shields generated by the leased equipment. If the lessee is unable to utilise the depreciation and interest expense deductions from corporation tax because of the high operating losses and/or other tax allowances, it can partially utilise the tax incentives associated with asset purchase by leasing the asset. Other rationales for leasing include lessee’s debt capacity, asset type and salvage value, conservation of working capital, ease of obtaining credit by firms with poor credit ratings, flexibility and convenience and resolution of agency conflicts. These benefits of leasing could make previously rejected projects based on the purchase of the asset acceptable. Empirical evidence provided to-date is, however, mixed. Finucane (1988) and Mehran and Taggart (1995) show that tax-related factors are not significantly associated with the level of leasing by a firm. In contrast, Barclay and Smith (1995), Sharpe and Nguyen (1995) and Graham, Lemmon and Schallheim (1997) find that companies with high proportion of tax-losses rely more on lease finance suggesting that leases are used more heavily by firms for which the tax-benefits of ownership appear low. Similarly, inconsistent with the theory, a number of studies show that debt financing is a complement not a substitute to leasing (e.g., Bowman (1980); Ang and Peterson (1984); Finucane (1988)). However, after controlling for lessee’s debt capacity, leasing is found to be a complement for debt financing (e.g., Marston and Harris (1988); Krishnan and Moyer (1994); Sharpe and Nguyen (1995)). Furthermore, the extent to which leasing is determined by the resolution of potential agency conflicts is difficult to test because of the lack of data on firm’s asset types. However, consistent with the resolution of agency conflicts, leasing activity is found to be more prevalent in certain industries (e.g., Finucane (1988) and Krishnan and Moyer (1994)), in firms with assets that make good collateral (e.g., Finucane (1988)), in firms with high growth opportunities and those that are not regulated (e.g., Barclay and Smith (1995)), in firms with high proportion of insider ownership (e.g., Mehran and Taggart (1996)) and in smaller firms (e.g., Barclay and Smith (1995) and Sharpe and Nguyen (1995)). The issue of size is, however, controversial. Barclay and Smith (1995) and Sharpe and Nguyen (1995) used size as another proxy variable for asset type and the resolution of agency conflicts. They argue that large diversified firms are less likely to rely on leasing than smaller firms because they are less concerned with internal redeployment possibilities. However, Jensen (1986) argues that agency problems are more likely to prevail in large mature firms. Thus, if leasing mitigates agency costs, we would expect large firms to lease more than smaller firms. The purpose of this paper is to extent this literature by analysing the leasing decision of small versus large companies and of quoted versus privately held companies. Although, as in previous studies, we consider
2
firm size as a measure of the extent to which firms have the ability to redeploy assets internally, we also believe that the determinants of the leasing decision are likely to be size dependent because of the differences in the financing opportunities available to small and large companies and in their potential agency costs. We analyse financial statements of more than 3,000 companies registered in the UK over the sample period 1/04/1982 to 31/03/1996. We focus on all unquoted and publicly quoted companies for which the financial and accounting data is available in machine readable form. Our analysis in centred on finance lease and hire purchase and exclude operating lease which is a short-term, cancellable lease. For the sample as a whole, we find strong evidence that companies that use leasing have higher tax losses, higher debt-to-equity ratio, are larger and invest significantly more than non-lessee companies. Thus, our results suggest that leasing contributes to the financing of fixed capital formation and that leasing may be the cheapest source of finance. However, when we split our sample into size deciles using either total assets, sales and, for quoted companies, market value of equity, we find that the determinants of leasing are size dependent. We show that, for small companies, taxation does not have a significant impact on the probability of leasing. Unlike large companies, small quoted and all unquoted companies do not carry a larger proportion of tax carry forward in their accounts and do not report higher relative tax recoverable than nonlessee companies. In contrast, the leasing decision of small firms is substantially affected by their growth opportunities, while, for large companies, Tobin’s q, used as a proxy for growth potentials, is not significant. We also find strong evidence that, for quoted and unquoted small and medium-sized companies, leasing is a substitute for debt financing. In contrast, for large firms, leasing is a complement to debt financing. Furthermore, we show that, on average, lessee companies are significantly more profitable than non-lessee companies. This significant difference is particularly apparent for large companies. The results suggest that leasing contributes to these firms’ profitability and imply that firms with sophisticated financial management are likely to lease. In contrast, small lessee companies are less profitable than non-lessee companies. Given their poor performance, partly due to their high growth, small firms may find it difficult to use alternative sources of finance. In short, our results suggest that leasing contributes to the survival and to the financing of growth opportunities of small companies, while taxation is the main determinant of large companies’ leasing decision. The rest of the paper is organised as follows. Section 2 presents a review of the literature and the hypotheses tested. In Section 3, we discuss the data and the methodology employed. In Section 4, we present our empirical results. Conclusions are in Section 5.
2. Review of the Literature Where the purchasing firm (lessee) and the lessor have the same tax status, borrow and lend at the same rate of interest, and have similar expectations regarding the salvage value of the asset, there is no advantage to leasing over purchasing. In practice, these perfect capital market conditions are not satisfied, resulting in a number of rationales for
3
leasing. Previous studies have identified the following three main reasons for the existence of leasing: •
tax differential : If the lessee pays little or no corporation tax, he/she will pass on the capital allowances to the lessor. Part of these allowances will be returned to the lessee through lower rental payments.
•
debt substitutability : Leasing can be a substitute for debt finance because both of them reduce debt capacity. However, given the fact that lessors have first claim on the asset leased, leasing is likely to be advantageous for financially distressed companies.
•
agency costs : Modern corporations characterised by a divorce between ownership and control are likely to suffer from the free cash flow problem where managers undertake negative NPV projects. Given that leasing is not an investment decision and lessors have first claim over the asset, it can reduce the agency conflict.
In this section we review the previous literature relating to these effects.
2.1.
Taxes and leasing
Traditionally, the theory of financial leasing has focused on the differential tax position of the lessee and the lessor as the primary rationale for leasing.1 The fundamental argument is that, if a firm is not in a full tax-paying position, purchasing and depreciating an asset may be costly as no or lower capital or depreciation tax allowances are claimed. However, by leasing the asset, the lessor would claim the tax allowances which could be transferred indirectly to the lessee through lower lease payments. Thus, while the after-tax NPV of the asset if purchased could be negative, the lease possibility will make the investment a positive NPV project. DeAngelo and Masulis (1980) show that when firms’ debt capacity to fully use tax deductions is limited, their use of debt financing is reduced. Empirically, MacKieMason (1990) study incremental financing decisions using discrete choice analysis to find that tax shields affect significantly the choice between issuing debt or equity. Similarly, Graham (1996) show that the incremental use of debt is affected by the simulated firm-specific marginal tax rates. Using UK data, Lasfer (1995) shows that firms that pay lower taxes, after accounting for stock relief, capital allowances, trading losses and ACT recoverable, are likely to have lower debt financing in their capital structure. In particular, firms that are tax exhausted use less debt than tax-paying firms. Under this framework, Lewis and Schallheim (1992) model the leasing and borrowing decision. They focus on leasing as a means for selling excess, non-debt tax deductions. In their model, non-debt tax shields are sold via leasing, therefore reducing the potential redundancy with interest deductions and making the marginal value of debt 1
See, for example, Bower, 1973; Brealy and Young, 1980; Lewellen, Long and McConnell, 1976; Miller and Upton, 1976; Myers, Dill and Bautista, 1976; and Brick, Fung and Subrahmanyam, 1987.
4
positive. The lessee responds by using additional debt. In this way, Lewis and Schallheim establish the theoretical possibility of a positive relationship between debt and lease financing, even within the same firm. (The issue of the relationship between debt and leasing is discussed in the next section). Furthermore, in this model, the benefits from leasing are realised even if the marginal tax rate is the same for the lessee and the lessor. Empirical evidence provided to date on the influence of taxes on leasing is mixed. For example, Finucane (1988) show that tax-related factors are not significantly associated with the level of leasing by a firm. These results may, however, be driven by the fact that Finucane looked at ‘capital’ leases, as defined by FASB Statement No 13, which are not likely to be affected by tax factors because they are treated by the Inland Revenue Service as instalment sales contracts for tax purposes. Mehran and Taggart (1995) use the ratio of reported tax less change in deferred tax over earnings before interest and tax to estimate the impact of taxes on leasing for a sample of 134 large US companies over the period 1979-80. They find that the coefficient of this variable is not significant. These results are likely to be driven by the lower number of firms analysed and the shorter sample period. Other studies find a strong evidence of tax effects. Barclay and Smith (1995) find that companies with high proportion of tax-loss carry forward rely more on lease finance. Sharpe and Nguyen (1995) construct two alternative proxies for a firm’s tax status. The first is the ratio of tax expense over pretax income. The second is a dummy variable equal to one if the firm reported in its financial statements tax-loss carry forward. These firms are considered to be tax exhausted and thus unable to take full advantage of the tax benefits of ownership. These two measures are found to be significant, suggesting that capitalised leases are used more heavily by firms for which the tax-benefits of ownership appear low. Graham et al (1997) compute the marginal effective corporate tax rates and consider only operating leases which are likely to be true leases for tax purposes. They show that a change in the marginal tax rate from 0 to 46 percent will, on average, result in 19 percent decrease in the firm’s ratio of operating leases to firm value and in a 7 percent decrease in the ratio of capital leases to firm value. 2.2.
Leasing and debt capacity
At the same time as leasing is related to taxes, Finance theory has considered leasing as a substitute for corporate borrowing. Myers, Dill and Bautista (1976) and Franks and Hodges (1978) view leasing and long-term debt as fixed, contractual obligations. Both leasing and debt reduce firm’s debt capacity, and, as a consequence, greater use of lease financing should be associated with less reliance on debt. However, empirical evidence contradicts this approach. A number of studies show that greater use of leasing tends to be associated with more debt financing. For example, using a sample of 92 US firms in 1973, Bowman (1980) find that firms with high levels of outstanding debt engage also in leasing activity. Ang and Peterson (1984) use a Tobit analysis on cross-sections of about 600 firms over the 1976-81 period to estimate the relationship between the likelihood and the extent of leasing activity and a firm’s debt ratio and other explanatory variables. Their results show a positive and statistically significant relationship between leasing activity and debt ratios. Finucane (1988) also conducted a Tobit analysis over the period 1981-85 and
5
shows that leasing and debt financing are positively correlated. Moreover, Finucane shows that firms in certain industries, such as air transport and retailing, rely more on leasing. His cross-sectional analysis revealed that the lease ratio (capital leases to total assets) is related to the level of mortgage debt and the bond rating where firms with lower bond ratings are found to lease more frequently. The above studies, however, fail to control for the underlying factors that determine debt capacity. Smith and Wakeman (1985) argue that the results of Ang and Peterson (1984) probably reflect the difficulties of controlling for debt capacity. They argue that firms with higher debt capacity may also have other characteristics that make leasing relatively attractive. In particular, firms with certain asset characteristics are likely to have greater debt capacity, and, as such, they can afford to use more lease and debt financing than other firms. A number of more recent studies have analysed leasing decision after controlling for such considerations. Marston and Harris (1988) analyse the contemporaneous changes in leasing and changes in debt financing across a sample of firms. They find these two variables to be inversely related, confirming that lease and debt are substitutes. However, they find that firms that employ lease financing typically use higher levels of debt compared to firms that do not use leasing. Krishnan and Moyer (1994) hypothesise that leasing reduces bankruptcy costs in comparison to financing with ordinary debt while having all the advantages of secured debt. Under these considerations leases should be more widely used by riskier, less established firms. They find that lessee firms have lower retained earnings, high growth rates, lower coverage ratios, higher debt in their capital structure higher operating risk and lower z-score than non-lessee firms. Their evidence suggest that as bankruptcy potential increases, lease financing becomes an increasingly attractive financing option. Nonetheless, their analysis ignores operating leases and examines the use of capital leases which are not driven by taxes in the US. Sharpe and Nguyen (1995) analyse the intensity to use both operating and capital leasing. They hypothesise that a firm’s propensity to lease is a function of the type of capital required and the extent of leasing-related transactions costs associated with such assets. They controlled for these unobservable factors by analysing a firm’s propensity to lease relative to other firms in its own industry. They find that leasing propensity - operating and capital leases over book value of fixed assets - is substantially higher for lower-rated, non-dividend-paying and poor-cash firms. Their results suggest that leasing is used extensively by firms that are likely to face relatively high premiums for external funds. A number of other studies provide survey evidence in favour of lease-debt substitution. For example, Mukherjee (1991) asked 103 chief financial officers of Fortune 500 firms whether they viewed debt and leasing as substitutes, complements or independent financing instruments. While 22 of the respondents felt that the relationship is complementary and 31 saw the two as independent, 47 reported that lease and debt financing are substitutes.
2.3.
Leasing and agency costs
6
Another set of arguments for the determinants of leasing focus on agency and contracting costs. Smith and Wakeman (1985) provide a unified analysis of the various incentives affecting the lease-versus-purchase decision and suggest that taxes are important in identifying potential lessees and lessors but they are less important in identifying the specific assets leased. They suggest that firms are unlikely to lease assets that are highly specific to the organisation because the resulting bilateral monopoly problem would create agency conflicts between the lessor and the lessee. They predict that leasing is more likely to occur if the value of the asset is not specialised to the firm. In this case, firms are likely to lease generic office facilities than more firm-specific production and research and development facilities. They also predict that leasing is likely to occur if the lessor has market power and if the lessor has comparative advantage in asset disposal. Similar conclusions are reached by Williamson (1988) who concludes that assets that are easily redeployable, i.e., assets with resale value and not firm-specific, are likely to be leased. Empirically, the extent to which leasing is determined by the resolution of potential agency conflicts is difficult to test. The main reason relates to the lack of data on firm’s asset types. However, previous studies have used a number of proxy variables to measure the impact of asset type on leasing propensity. The first proxy variable is the industry factor. Assets used by firms in a particular industry could easily be identifiable and their suitability for leasing could be assessed. For example, Finucane (1988) and Krishnan and Moyer (1994) find that leasing activity is more prevalent in certain industries than in others. In particular, firms in transportation, services and wholesale and retail trade are more likely to use leasing. This suggests that assets leased in these industries, such as aircraft and retail space, are easily redeployable. Moreover, Finucane (1988) shows that firms that use mortgage secured notes or bonds are more likely to use leasing. This suggests that firms with assets that make good collateral are also likely to have assets conductive to leasing. The second proxy variable is the split of firm’s market value into assets in place and the proportion of the value that is accounted for by future growth opportunities. There are a number of mechanisms that can be used to reduce the agency problems between managers and shareholders. Under the agency cost framework, firms with a higher proportion of growth opportunities should use less debt financing to mitigate the underinvestment problem (Myers, 1977). Stulz and Johnson (1985) demonstrate that high-priority claims, such as leasing, can help reduce the underinvestment problem. Empirically, Barclay and Smith (1995) find that firms with greater growth opportunities, as measured by book-to-market ratio, rely more heavily on lease financing. Barclay and Smith (1995) also use the special case of regulated companies to test for the effect of investment opportunities on leasing. They argue that regulation reduces the possibility for corporate underinvestment because the regulator oversees these firms’ investments decisions. They find that regulated firms, such as gas, electric utilities and telecommunications, use lower proportion of capitalised leases but higher long-term debt and ordinary debt. An alternative mechanism that can work to reduce the agency problem is the ownership structure (Shleifer and Vishney (1986)). Smith and Wakeman (1985) consider the potential role of ownership structure as a determinant of leasing activity. They predict that leasing is more likely to occur if the firm is closely held because leasing acts as a risk reduction mechanism for such firms, especially if the lessor has a
7
comparative advantage in disposing of the asset in the second hand market. Empirically, Mukherjee (1991) show that the desire to lay off obsolescence risk is one of the motives for leasing. Mehran and Taggart (1996) find that firms with high proportion of insider ownership engage more in leasing. The third proxy variable used for asset type is firm size. Firm size can be a measure of the extent to which firms have the ability to redeploy assets internally. Large diversified firms are less likely to lease assets because they are less concerned with redeployment possibilities. Empirically, Barclay and Smith (1995) and Sharpe and Nguyen (1995) find that large firms are less likely to rely on leasing than smaller firms.
3.
Data and Methodology
We analyse financial statements of all unquoted and publicly quoted UK companies for which the financial and accounting data is available in machine readable form. Our study covers a total of 3,008 individual companies over the period 1982 to 1996 resulting in 23,411 pooled time-series and cross-sectional observations. To avoid survivorship bias, we include in our sample live as well as companies that were delisted during our sample period due to bankruptcy or takeover. Our analysis in centred on finance lease and hire purchase and exclude operating lease which is a short-term cancellable lease.2 We use the amount reported under “Finance Lease and Hire Purchase” in the “borrowing” section of each individual company’s balance sheet to document the extent to which leasing contributes to the financing of small and medium-sized firms’ growth and survival. We use publicly available information, including annual reports, Extel Financial and Datastream, to extract the relevant data for all our sample. We classify each individual company into financial years spanning from 1 April of year t to 31 March year t+1, depending on the date of its year-end. For example, 1995 includes all UK companies with year-ends between 1 April 1995 to 31 March 1996. Table 1 reports the annual distribution of the total number of companies covered in this paper, and the number and the proportion of companies that reported “Finance Lease and Hire Purchase” in their annual reports the total number of companies covered in this paper. The number of companies included in our analysis ranges from 37 in 1982 to 2,650 in 1993. The rise between 1982 and 1993 in the number of companies and the slight reduction in the number of companies in 1994 and 1995 is due to coverage variations by the database vendors. Up to 1984 the number of companies that use leasing is relatively low. During the 1982-84 period, the reported figure of finance lease and hire purchase is not likely to reflect the actual lease commitments because companies were able to report their 2
Unlike operating leases, the capitalisation of finance leases is mandatory after the advent of SSAP21 in 1984. This accounting standard, extended recently by FRS5, specifically defines a finance lease as a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee. All other leases should be accounted for as operating leases. SSAP21 stipulates that leased assets must be included among fixed assets and that future rental obligations be recorded as liabilities under “Finance Lease and Hire Purchase” in the “Borrowings” section of the balance sheet.
8
leases in the off-balance sheet financing section. In contrast, the 1985-1995 period provides a better appreciation of the intensity of the use of leasing in the UK as in 1984 companies had to comply with the requirements of SSAP21. The proportion of companies that use leasing has risen substantially between 1985 and 1988. For example, in 1988, out of 1,895 companies included in our sample, 1,052 companies (55.5 per cent) reported Finance Lease and Hire Purchase in their accounts. Over the sample period 1988 to 1995, the majority of companies in the UK use leasing. On average, the proportion of companies that use leasing over the whole sample period is 54.5 per cent; 57 per cent of our sample of quoted companies and 52 per cent of our sample of unquoted companies. [Insert Table 1 here] We use univariate and logit regressions to analyse the determinants of firms’ leasing decision. A number of proxy variables are defined to test the hypotheses developed in the previous section. To evaluate the tax impact on the decision to lease rather than buy assets, we define the following variables:3 1. Tax charge/Profit before tax: This variable is expected to capture firms’ effective corporate tax rates. In general, the reported tax charge in the profit and loss account is not equal to the profit before tax times the statutory corporation tax rate. The taxable profit is adjusted for the following factors: •
expenses that are disallowed or income which is tax-free or taxed at a rate other than that of the UK Corporation Tax;
•
proportion of tax to be paid at some time, but not in the year being reported upon;
•
losses and/or unrelieved Advanced Corporation Tax (ACT) carried forward.
Companies for which the above adjustments are high will have lower tax charges. If leasing is motivated by the firm’s tax position, the ratio of tax charge over profit before tax should be lower for lessee companies. 2. Tax recoverable: This variable is the reported corporation tax, other than Advanced Corporation Tax, carried in the accounts to be set against future corporation tax liability. This variable is expected to be higher for lessee companies if leasing is driven by tax savings. To account for size differences, we also report results based on the ratio of tax recoverable to total assets. The following additional tax variables are specific for quoted companies:
3
For full description of the UK tax system see, for example, Deveureux, 1987, Lasfer, 1995, Lasfer, 1996, and Levis, and Morgan, 1985.
9
3. ACT recoverable: This variable is the amount of ACT that is to be set against future tax liability. Under the UK imputation system, firms have to pay income tax at the basic rate on behalf of shareholders on each unit of dividend distributed. This tax is then deducted from the corporation tax liability if earnings on which dividends are paid are generated in the UK and if taxable profits are positive. We assume that ACT recoverable reported in the accounts is the result of tax losses. Thus, companies with high ACT recoverable are likely to use leasing to save in taxes. This variable is deflated by total assets and market value of equity. 4. Provision for ACT recoverable: This variable is the amount of provision set by firms to account for possible non-recoverability of ACT. This variable should be high for lessee companies if leasing is driven by tax considerations. This variable is deflated by total assets and market value of equity. 5. ACT written off: If the recoverability of ACT is not certain in the foreseeable future, companies are allowed to write off ACT against reserves. Thus companies with high ACT written off are likely to be tax exhausted and thus, likely to use leasing. This variable is deflated by total assets and market value of equity. In order to assess the impact of agency costs effects on leasing we define the following variables to measure growth opportunities: •
Additions to Other Tangible Fixed Assets: This variable is the reported fixed capital investment in the firm’s cash flow statements. It excludes property and investments. The higher this variable, the higher the growth, thus the high the leasing propensity. This variable is also deflated by total assets to account for size differences across firms.
•
R&D/Sales: This variable is the reported research and development costs in the firms’ profit and loss account, deflated by total sales. We assume that growth firms have high R&D propensity. However, this variable may reflect asset specificity, thus lower leasing, than growth.
•
Sales growth: This variable is the average percentage change in turnover over two consecutive financial years. Companies with high sales growth are assumed to be at growth stage.
•
Payout ratio: This variable is the ratio of dividend over earnings. It is included only for quoted companies for which the data is available. It is expected that growth firms should pay less dividends compared to mature companies.
•
Tobin’s q: This variable is the ratio of market value of equity to shareholders’ fund. Tobin’s q is extensively used in the literature to measure growth opportunities. The higher this variable the higher the firm’s growth opportunities, and the higher the leasing propensity.
10
In order to determine the impact of debt financing on the leasing propensity of our sample firms, we construct the following variables: •
Gearing: This variable is the ratio of long-term debt to capital employed. Capital employed is defined as the sum of long-term debt plus book value of equity. If leasing is a substitute for debt financing, we would expect lessee companies to exhibit lower gearing ratios than non-lessee companies.
•
BKL/TD: This variable is the ratio of bank loan and overdraft to total debt. This ratio measures the extent to which firms with high bank loans and overdraft use leasing because they are prevented from increasing their loan commitments and/or that leasing is a relatively cheaper source of finance than bank loans.
We define the following variables to analyse the link between the probability of using leasing and firm’s profitability:
4.
•
PBIT: This variable is the profit before interest and tax.
•
PBT: This variable is the profit before tax, i.e., PBIT less tax charge.
•
ROE: This variable is the return on equity, i.e., earnings divided by shareholder’s funds.
•
EPS: This variable is the earnings per share, adjusted for any capital changes.
•
DPS: This variable is the dividend per share, adjusted for any capital changes.
•
Dividend Yield: This variable is the ratio of dividend per share to year-end share price.
Empirical Results
In this section we present our empirical results. We first discuss the results based on Univariate analysis where the difference between lessee and non lessee firms in each of the potential determinant of leasing is analysed. In the second sub-section the joint hypotheses are explored through the logit regressions. 4.1.
Univariate analysis
In this section, we analyse determinants of the leasing decision. We do this by comparing the size, tax position, debt-equity ratio, growth opportunities and profitability of lessee and non-lessee companies. We carry this analysis, first, for the whole sample, and then we split the sample into large medium and small firms and into quoted and unquoted firms. 4.1.1 Leasing and firm’s size
11
Table 2 presents a summary of the size differences between lessee and non-lessee companies and quoted and unquoted companies. Panel A of Table 2 shows that our sample as a whole is split into 54.5 per cent lessee firms and 45.5 per cent non-lessee companies.4 This coverage is not size or quotation status dependent as shown in Panel B, and Panel C of Table 2. Panel A of Table 2 also shows that the average leasing propensity, i.e., the ratio of Finance Lease and High Purchase to Total Debt, of all lessee companies in the sample is 21.60 per cent. However, the distribution of leasing propensity across firm size is not homogeneous. Leasing represents 12.76 per cent of total debt for larger companies, 22.20 per cent for medium-sized companies (decile 5) and 33.89 per cent for smaller firms. This size difference is also apparent in the case of quoted (Panel B, Table 2) and unquoted companies (Panel C, Table 2). Larger lessee quoted companies are financed at 9.33 per cent through leasing, while smaller companies’ leasing amount to 34.85 per cent of their total debt. Unquoted large and medium-sized companies have a higher leasing propensity than quoted companies, partially because quoted companies are larger than unquoted ones. Our results are consistent with the US evidence5 and suggest that smaller companies are much more in need for leasing than larger firms. Table 2 reports also size differences between lessee and non-lessee companies and between quoted and unquoted companies. In general, lessee companies are of the same size or even larger than non-lessee companies. For example, smaller lessee companies have higher total assets than smaller non-lessee companies. In contrast, larger and medium-sized lessee companies have higher turnover and market value of equity than non-lessee companies. Furthermore, as expected, quoted companies are larger than non-quoted companies, whether size is defined in terms of total assets or turnover. [Insert Table 2 here] 4.1.2 Leasing and firms’ tax capacity To analyse the tax impact on leasing, we compare the tax position of companies that reported Finance Lease and Hire Purchase in their accounts against companies that did not use leasing. Table 3 reports the mean and the t-statistics of the tax differences between lessee and non lessee firms. Panel A, Table 3 shows that, for all lessee companies in our sample, the average tax charge over profit before tax (Tax/PBT) is 24.46 per cent. In contrast, for the non-lessee firms, the average is 29.2 per cent. While both these two rates are substantially lower than the average standard rate of corporation tax of about 35.5 per cent, lessee companies pay, on average, lower tax than non lessee. The difference between the two rates is not, however, statistically significant. Similarly, the differences in the effective corporate tax rates between the large, medium-sized and small lessee and non-lessee companies are not significant. Panel A, Table 3 reports also tax recoverable differences between lessee and nonlessee companies. Lessee companies exhibit significantly higher levels of tax 4 5
See Table 1 for time-series distribution of our leasing and non-lessee firms. See, for example, Barclay and Smith (1995) and Sharpe and Nguyen (1995).
12
recoverable (Tax rec.) than non-lessee firms. Our lessee companies have reported, over the sample period, an average of £1.13 million of tax recoverable, while nonlessee companies have reported only an average of £650,000. This significant contrast is observed also for large, medium-sized and small firms and when tax recoverable is deflated by total assets (Tax rec./TA). These results suggest that, when companies are not able to deduct all their allowances from their taxable profits, they prefer to lease, instead of borrowing and buying their assets. Panel B, Table 3 reports the results for quoted companies. Despite the fact that lessee companies have lower effective tax rates (Tax/PBT), the difference between lessee and non-lessee companies is not statistically significant. However, the other alternative tax measures provide strong support for the tax effects on leasing. Lessee companies have, on average, higher tax recoverable, higher ACT recoverable (ACTR), set up larger provisions for ACT recoverable (Pr. ACT) and write off larger amounts of ACT (ACTWO) against their reserves than non-lessee companies. These tax variables are also significantly larger for lessee firms when they are deflated by total assets (TA) or market value of equity (ME). These results hold also, but to a lesser extent, for medium-sized companies. For small quoted companies, the tax effect on leasing is less strong. Small lessee companies have higher tax carry-forward and relative ACT recoverable than non-lessee companies. Panel C, Table 3 reports the results for the unquoted companies. Unlike the results reported for the quoted companies sample, taxation cannot explain fully the leasing decision of the unquoted companies. For example, small unquoted companies have significantly larger effective corporation tax rates (Tax/PBT) than non-lessee companies. Similarly, all unquoted lessee companies report, on average, a lower level of tax recoverable (Tax rec.) than non-lessee companies. These two results are not consistent with the tax propositions and suggest that, for unquoted companies, the decision to lease is not driven by tax savings. However, medium-sized companies’ leasing decision is driven by taxation. They reported an average of £0.05 million of recoverable tax against £0.02 million reported by non-lessee companies. This represents 0.14 per cent of the lessee companies’ total assets and 0.05 per cent for the non-lessee companies. The differences in both these variables between the lessee and the non-lessee companies are statistically significant. Furthermore, smaller lessee unquoted companies also report higher relative tax recoverable than the non-lessee companies. The difference between the two groups is not, however, statistically significant. [Insert Table 3 here] 4.1.3 Leasing and Firm’s growth opportunities Agency and contracting costs could also drive the leasing decision. Under this framework, leasing is more likely to occur if the asset is not specialised to the firm and if it is easily redeployable. It is predicted, for example, that large diversified firms are less likely to lease because they are less concerned with external redeployment possibilities and that firms with high growth opportunities should rely more on leasing. Table 4 reports the growth differences between lessee and non-lessee companies. As expected, lessee have significantly larger additions to other tangible fixed assets (add. 13
OTFA) than non-lessee companies independently of whether they are quoted or unquoted. In contrast, difference in R&D propensity is not statistically significant between the lessee and non-lessee companies for all, quoted and unquoted companies. However, this variable is likely to measure firm’s asset type. It suggests that firms are not likely to lease their specific production and research and development facilities because these assets are specialised to them. Thus, firms are likely to buy these assets than to engage in leasing. The lessor’s incentive to lease may be reduced and the rental payments for the lease of these specific assets may be very high because the lessor has no comparative advantage in disposing of the assets. Sales growth is only significant for the case of all and quoted large firms (Panel A and Panel B, Table 4.) Panel B, Table 4 reports the main difference between lessee and non-lessee companies in growth potential, as measured by Tobin’s q. For all quoted companies, lessee companies have significantly larger Tobin’s q than non-lessee firms. The average market value of equity to book value of equity for all quoted lessee companies is 3.63, while that of the non-lessee companies is 2.58. However, this statistically significant difference is observed only for small quoted companies. For larger and medium-sized companies, leasing decision is not driven by growth potential. Panel B, Table 4 reports also the dividend payout differences between the lessee and the non-lessee companies. Although, in most cases lessee companies exhibit lower dividend payout ratios than non-lessee companies, the difference between the two groups is not statistically significant. This may be due to the fact that dividends convey information to the market and that managers have not a total discretion over the amount they have to pay. [Insert Table 4 here] In sum, our results provide a strong evidence on the effect of growth potential on the leasing decision. Firms with high fixed assets investments are more likely to use leasing. However, firm specific fixed assets are not likely to be leased. Finally, small firms with high growth opportunities are more likely to lease than to buy their assets. Our results suggest that leasing contributes significantly to the financing of growth of UK companies.
4.1.4 Leasing and firm’s debt capacity Previous studies show that leasing is a substitute for debt finance. Table 5 presents the gearing differences between the lessee and non-lessee companies. Panel A shows that, on average, companies with significantly high gearing and those with substantially lower bank commitments are likely to engage in leasing. However, the distribution of these variable across large, medium-sized and small firms is not homogeneous. Large lessee companies have, in fact, significantly higher gearing and are more committed to bank loans than non-lessee companies. Thus, for large firms, leasing tends to be associated with high debt finance. In contrast, medium-sized and small lessee firms are significantly less committed to bank financing. Medium and smaller non-lessee firms exhibit significantly higher ratio of bank loans and overdrafts than lessee firms. Thus, for medium-sized and smaller firms leasing is a substitute for debt finance. These firms
14
gearing is not statistically different from their lessee counterparts. Similar results are shown for the case of quoted companies (Panel B, Table 5) and for unquoted companies (Panel C, Table 5). [Insert Table 5 here] In sum, the gearing differences between lessee and non-lessee firms is not homogeneous across firms of different size. While for the whole sample lessee companies have, on average, higher gearing and lower relative bank loans, than nonlessee companies, for large companies leasing and debt finance are complement and for medium-sized and smaller firms, leasing and debt finance are substitutes. The results suggest that for medium-sized and smaller firms leasing is a cheaper source of finance. Similar to US evidence6, our results also imply that leasing is widely used by riskier and less-established firms. 4. 1. 5 Leasing and firm’s profitability In this section, we provide empirical evidence on the relationship between leasing propensity and firms’ profitability. Previous studies show that leasing is used by less profitable companies, i.e., companies with high premiums for external funds. Table 6 provides the empirical results on the profitability differences between lessee and non-lessee companies. Panel A, Table 6 shows that, on average, all our lessee companies are more profitable than non-lessee companies. For example, the average profit before interest and tax of lessee companies amounts to £36.4 million while that of non-lessee companies is £29.90 million. The difference between these two groups is statistically significant. Large lessee companies are, also, more profitable than non-lessee companies. Large lessee companies have significantly higher profit before interest, profit before tax, and, to a lesser extent, higher return on equity, than non-lessee firms. This relationship does not hold, however, for medium-sized and smaller firms. In particular, smaller lessee companies have significantly lower profit before interest and tax than non-lessee companies. On average, the profit before interest and tax of small lessee companies is about £1,000 while that of non-lessee companies is £21,000. The same applies for profit before tax and return on equity, but the difference between lessee and non-lessee companies is not statistically significant. Panel B, Table 6 reports the results of profitability differences between quoted lessee and non-lessee companies. All quoted lessee companies generate higher profit before interest and tax and profit before tax than non-lessee companies. Although the other profitability measures are higher for lessee than for non-lessee companies, the difference between the two groups is not statistically significant. Larger quoted lessee companies have also higher profit before interest and tax, higher profit before tax and significantly higher yield than non-lessee firms. Similarly, medium-sized lessee companies have substantially higher profits, but lower yield, than non-lessee companies. For smaller companies, leasing predominates among less profitable companies. In particular, small lessee companies have significantly lower profit before interest and tax, lower earnings per share and lower dividend per share than non-lessee firms. Our results suggest that for large and medium6
See, for example, Krishnan and Moyer (1994).
15
sized quoted companies, leasing contributes to firms’ profitability while, for small companies, leasing contributes to their survival. Panel C, Table 6 provide the results for the non-quoted companies. On average, all and large lessee unquoted companies have lower profit before interest and tax than non-lessee companies. However, large lessee unquoted companies have higher profit before tax than non-lessee companies. Although small unquoted companies with leasing in their capital structure have lower profit before tax and higher profit before interest and tax and return on equity, the difference between the two groups is not statistically significant. [Insert Table 6 here] Therefore, in sum, our results suggest that leasing to large companies is associated with profitability; large profitable companies are those that lease rather than buy their assets. In contrast, for small companies. leasing is associated with low profitability. Small lessee companies exhibit, on average, lower earnings and accounting returns than non-lessee companies. Our results imply that leasing contributes to the survival of smaller companies.
4.2
Logit analysis
In this section we present the results of the logit regressions. The dependent variable is a dummy variable equal to 1 if the firm is using leasing and to zero otherwise. Table 7 reports the results for all companies in the sample and for quoted and unquoted companies. The results show that, for all companies in the sample, tax recoverable, additions to fixed assets, leverage and size are all positively correlated to the probability of using leasing. The results are relatively similar for quoted companies. Companies with high tax carry-forward, ACT recoverable and those that expect to have difficulties in recovering their ACT (i.e., those that set high provision for ACT recoverable) are more likely to lease than buy the asset. Our results are consistent with US evidence (e.g., Barclay and Smith (1995), Sharpe and Nguyen (1995) and Graham et al (1997)) and suggest that capitalised leases are used more heavily by firms for which the tax-benefits of ownership appear low. The results also show that the probability of leasing by quoted companies is positively related to growth opportunities as measured by additions to fixed assets and Tobin’s q, to leverage and to firm’s size. However, leasing is not associated with research and development expenditures. Our results are consistent with Barclay and Smith (1995) and suggest that leasing mitigates the agency conflicts. The last five columns of Table 7 report the results for unquoted companies and show that leasing is not driven by tax variables, but only by investments in fixed assets, leverage and size. Given that size is the main difference between quoted and unquoted companies, our results suggest that, leasing of small companies is not likely to be driven by tax factors. [Insert Table 7 here]
16
Table 8 expands these results by analysing the determinants of leasing of only small companies (the first decile sorted by total assets). Tax variables are either not significant or significant but with the wrong sign. The results suggest that small firms do not lease to save in taxes. Instead, the results show that investments in fixed assets, Tobin’s q, leverage and size are positively related to the probability of leasing. In addition profitability is negatively related to leasing suggesting that less profitable small firms are more likely to use leasing than buying the assets. Our results are consistent with US evidence (e.g., Krishnan and Moyer (1994) and Sharpe and Nguyen (1995)) but suggest that lease financing becomes an attractive financing option for only small firms that are in financial distress. However, given the high growth options of small firms that use leasing, their relatively low profitability may be due to their operating expenses than to their inefficiency. [Insert Table 8 here] Table 9 reports the results of the largest companies in the sample (the tenth decile). The results show that various tax measure are correctly signed and significant. In contrast, Tobin’s q, which measures growth opportunities, is not significant. The results suggest that, unlike small companies, large firms are not likely to lease to finance their growth potentials. For large quoted companies, our results indicate that profitable companies, as measured by EPS, are more likely to lease their assets. However, size, as measured by the total assets is negatively related to leasing. The results suggest that large companies with low assets are more likely to lease. [Insert Table 9 here]
5.
Conclusions
The purpose of our analysis is to determine the extent to which leasing is supporting the level of fixed investment undertaken by various size companies in the UK. To do this, we analysed financial statements of more than 3,000 individual companies registered in the UK over the 1982-1995 sample period. We analyse the probability of using leasing by comparing the financial performance and other characteristics of companies that reported financial lease and hire purchase in their accounts to companies that did not. We show that, for the sample as a whole, companies that use leasing are more likely to have tax losses, high debt-to-equity ratio and to be larger than companies that do not use leasing. In particular, our results show that companies with high fixed capital investment are more likely to use leasing than companies with low additions to other than buildings and property tangible fixed assets. Our results suggest that leasing contributes significantly to the financing of fixed capital formation of a large number of UK companies and imply that without leasing many projects would not have been undertaken. Our results reveal, however, that the reasons for leasing are not the same across companies of different size. We show that, for small firms, taxation is not the major determinant of leasing. Instead, leasing is driven by growth opportunities; small
17
growth firms are more likely to lease than small mature companies. Furthermore, our results show that leasing allows small companies to survive. We show that small less profitable companies are more likely to lease than other small cash-generating firms and small lessee firms have, on average, substantially lower bank borrowing than nonlessee companies. While these results imply that these lessee firms cannot access the debt market because of their low profitability, they could also suggest that, because of potential internal and external agency costs, small growth firms prefer to lease than to borrow-and-buy their assets. Similarly, the lack of profitability of small lessee firms could be due to the financing of their growth opportunities. For large firms, leasing appears to be driven by tax savings. We show that large firms that lease their assets are more likely to have high tax carry-forward and, for quoted companies, high ACT surplus than non-lessee firms. Leasing is also driven by profitability. Large lessee companies are, in general, more profitable than non-lessee companies. Moreover, for these large companies, leasing is a complement to debt financing. We show that large lessee firms have, on average, substantially higher relative bank loans than non-lessee companies. Our overall results suggest that leasing allows small firms to finance their growth and/or survival while for large firms, leasing appears to be a financial instrument used by sophisticated financial managers to minimise their after-tax cost of capital.
18
References Ang, J. and P.P. Peterson, 1984, The leasing puzzle, Journal of Finance 39, 1055-65. Barclay, M.J. and C.W. Smith, Jr., The priority structure of corporate liabilities, Journal of Finance 50, 899-917. Bayless, M.E. and J.D. Diltz, 1986, An empirical study of debt displacement effects of leasing, Financial Management 15, 53-60. Bower, R.S., 1973, Issues in lease financing, Financial Management 2, 25-34. Bowman, R.G., 1980, The debt equivalent of leases: An empirical investigation, Accounting Review 55, 237-253. Brealey, R. A. and C. M. Young, 1980, Debt, Taxes And Leasing - A Note, Journal of Finance 35, 1245-1250. Brick, I.E., W. Fung, and M. Subrahmanyam, 1987, Leasing and financial intermediation: Comparative tax advantages, Financial Management 16, 55-59. DeAngelo, H. and R.W. Masulis, 1980, Optimal capital structure under corporate and personal taxation, Journal of Financial Economics 8, 3-29. Deveureux, M., 1987, Taxation and the cost of capital: The UK experience, Oxford Review of Economic Policy 3, 17-32. Finucane, T.J., 1988, Some empirical evidence on the use of financial leases, Journal of Financial Research, 321-333. Freeman, H. and R. Griffith, 1993, Surplus ACT: A solution in sight? Fiscal Studies, 14, 58-73. Graham, J.R., 1996, Debt and the marginal tax rates, Journal of Financial Economics 41, 41-74. Graham, J.R., M.L. Lemmon and J.S. Schallheim, 1997, Debt, leases, taxes and the endogeneity of corporate tax status, Journal of Finance (forthcoming). Higson, C., 1991, The Problem of Surplus ACT, Mimeo, London Business School Krishnan, V.S. and R. C. Moyer, 1994, Bankruptcy costs and the financial leasing decision Financial Management 23, 31-42. Lasfer, M.A., 1995, Agency costs, taxes and debt: The UK evidence European Financial Management 1, 265-285. Lasfer, M.A., 1996, Taxes and Dividends : The UK Evidence, Journal of Banking and Finance (April), 455-472; Lease, R.C., J.J. McConnell and J.S. Schallheim, 1990, Realized returns and the default prepayment experience of financial leasing contracts, Financial Management 19, 11-20. Levis, M. and E. Morgan, 1985, The 1984 Budget: Effects on Corporate Tax and Investment, Discussion Paper, University of Bath. Lewellen, W. G., M. S. Long and J. J. McConnell, 1976, Asset Leasing In Competitive Capital Markets, Journal of Finance 31, 787-798. MacKie-Mason, J. K, 1990, Do Taxes Affect Corporate Financing Decisions?, Journal of Finance 45, 1471-1494. Martin, J.D., S.H. Cox and R.D. MacMinn, 1988, The Theory of Finance: Evidence and Applications, The Dryden Press, New-York. Mehran, H. and R.A. Taggart, 1996, Determinants of Corporate Leasing and Borrowing Activity, Northwestern University Working Paper. Miller, M. H. and C. W. Upton, 1976, Leasing, Buying, And The Cost Of Capital Services, Journal of Finance 31, 761-786.
19
Mukherjee, T. K., 1991, A Survey Of Corporate Leasing Analysis, Financial Management 20, 96-107. Myers, S.C., 1977, Determinants Of Corporate Borrowing, Journal of Financial Economics 5, 147-175. Myers, S.C., D.A. Dill and A.J. Bautista, 1976, Valuation Of Financial Lease Contracts, Journal of Finance 31, 799-819. Sharpe, S.A. and H.H. Nguyen, 1995, Capital market imperfection and the incentive to lease, Journal of Financial Economics 39, 271-294. Schallheim, J.S., 1994, Lease or Buy: Principles for Sound Corporate Decision Making, Harvard Business School Press, Boston, Massachusetts. Shleifer, A. and R.W. Vishny, 1986, Large Shareholders and Corporate Control, Journal of Political Economy (June), 461-488. Smith, C.W., and L. M. Wakeman, 1985, Determinants of corporate leasing policy, Journal of Finance 45, 895-908. Stulz, R. M. and H. Johnson, 1985, An Analysis Of Secured Debt, Journal of Financial Economics 14, 501-522. Williamson, O.E., 1988, Corporate finance and corporate governance, Journal of Finance 43, 567-591.
20
Table 1. Sample Characteristics N is for the number of companies in the total sample or quoted and unquoted subsamples; % is the proportion of companies that use leasing. Years
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 All
All Sample N 37 157 293 583 1,519 1,705 1,895 2,326 2,493 2,539 2,511 2,650 2,604 2,099 3,008
% 10.8 14.7 28.7 34.5 40.8 50.3 55.5 54.9 55.2 57.3 59.1 60.7 59.6 60.1 54.5
Quoted N 3 8 33 109 832 958 1,093 1,370 1,452 1,516 1,584 1,740 1,823 1,785 1,838
Unquoted
% 0.0 0.0 27.3 37.6 42.0 52.5 57.1 55.8 56.1 50.0 60.1 60.9 59.1 60.2 57.0
N 34 149 260 474 687 747 802 956 1,041 1,023 927 910 781 314 1,170
21
% 11.8 15.4 28.9 33.8 39.5 47.4 53.4 53.6 53.9 56.3 57.5 60.3 60.8 59.9 51.7
Total Assets of All Sample (£m) Mean Min. Max. 1,300 0 149 1,859 0 100 6,904 0 171 6,411 0 155 51,577 0 270 46,252 0 275 57,734 0 345 63,529 0 504 121,100 0 616 122,569 0 605 185,141 0 890 207,447 0 935 201,518 0 1,077 226,818 0 1,293 691 0 226,818
Table 2. Size differences between lessee and non-lessee companies The sample-firms is split into large (decile 10), medium-sized (decile 5) and small firms (decile 1) and into quoted and unquoted companies depending on whether the relevant company was trading on the London Stock Exchange at that particular time period. lessee firms are firms that reported Finance Lease and Hire Purchase in the Borrowing section in their Balance Sheet. % is the proportion of observations in each sub-sample; FLHP/TD is the ratio of Finance Lease and Hire Purchase over Total Debt; N is the number of observations for each sub-sample. There are 23,411 total usable observations, 14,306 for quoted companies and 9,105 for unquoted companies. * significant at 0.01 level.
All Companies Lessee
Nonlessee
Large Companies Lessee
Nonlessee
Medium-sized Companies Lessee
Nonlessee
Small Companies Lessee
Nonlessee
Panel A. All companies in the sample % FLHP/TD % N Total Assets £m
54.50 21.60 12,759 758.0 421.0
Sales £m
% FLHP/TD % N Total Assets £m
57.0 19.92 8,154 956.0 496.0
Sales £m 380.0 Market Value of Equity £m
45.50 52.32 47.68 55.40 0.00 12.76 0.00 22.20 10,652 1,225 1,116 1,297 776.0 6,673 7,054 38.30 (-0.23) (-0.53) 216.0* 2,940 1,236* 70.60 (10.4) (9.70) Panel B. Quoted companies
44.60 0.00 1,044 38.50 (-1.28) 58.20* (5.55)
55.70 33.89 1,304 3.30
57.80 21.30 827 38.20
42.20 0.00 604 38.50 (-1.52) 33.60* (13.84) 41.02 (-0.92)
56.20 34.85 804 3.40
47.80 0.00 435 38.40 (-0.19) 89.30 (-0.58)
54.40 31.60 496 3.10
43.0 0.00 6,152 839.0 (1.02) 212.0* (9.41) 280.0* (4.51)
55.48 9.33 794 7,650 3,381 2,673
44.52 0.00 637 7,748 (-0.40) 1,565* (7.41) 2,103* (3.32)
59.70 38.70
6.20
5.70 10.50
44.30 0.00 1,037 2.80* (7.40) 6.20 (-0.04)
43.80 0.00 627 2.90* (5.33) 6.30 (-0.38) 11.30 (-0.52)
Panel C. Unquoted companies % FLHP/TD % N Total Assets £m
51.76 25.53 4,713 417.0 291.6
Sales £m
48.24 0.00 4,392 682.0* (-4.0) 222.7* (4.75)
45.64 21.59 416 4,159 1,804
54.36 0.00 495 6,035* (-2.73) 754.0* (8.93)
22
52.20 23.52 476 38.40 86.90
7.30
45.60 0.00 415 2.50* (5.27) 6.06 (0.97)
Table 3. Tax differences between lessee and non-lessee companies The sample-firms is split into large (decile 10), medium-sized (decile 5) and small firms (decile 1) and into quoted and unquoted companies depending on whether the relevant company was trading on the London Stock Exchange at that particular time period. lessee firms are firms that reported Finance Lease and Hire Purchase in the Borrowing section in their Balance Sheet. Tax/PBT is the ratio of tax charge as reported in the Profit and Loss Account to Profit Before Tax. Tax rec. is tax carry forward reported in the balance sheet. TA is total assets. ACTR is ACT recoverable. Pr ACTR is the provision for ACT recoverable. ACTWO is ACT written off. ME is the market value of equity. There are 26,479 total usable observations, 16,299 for quoted companies and 10,180 for unquoted companies. * significant at 0.01 level. ** Significant at 0.10 level.
All Companies Lessee
Nonlessee
Large Lessee
Nonlessee
Medium-sized Lessee
Nonlessee
Small Lessee
Nonlessee
Panel A. All companies in the sample Tax/PBT
24.46
Tax rec. £m
1.13
Tax rec./TA
0.22
Tax/PBT
24.26
Tax rec. £m
1.64
Tax rec./TA
0.27
ACTR £m
1.29
Pr. ACT £m
0.86
ACTWO £m
0.19
ACTR/TA
0.37
Pr ACT/TA
0.10
ACTWO/TA
0.03
ACTR/ME
0.73
Pr ACT/ME
0.21
ACTWO/ME
0.13
Tax/PBT
24.79
Tax rec. £m
0.25
Tax rec./TA
0.11
29.2 32.83 27.7 31.94 (-1.39) (0.72) 0.65* 9.44 5.25* 0.08 (3.34) (3.03) 0.17* 0.20 0.14* 0.21 (3.74) (3.15) Panel B. Quoted companies 35.68 26.7 25.88 27.8 (0.18) (-1.40) 0.10 6.90* 12.40 0.83* (2.74) (3.62) 0.26 0.18* 0.25 0.21* (2.66) (3.18) 0.16 7.20 8.40 0.90* (1.33) (2.96) 0.03 3.30* 6.70 0.36* (3.43) (4.51) 0.001 0.85 0.09** 1.50 (1.35) (1.75) 0.27** 0.42 0.33 0.32* (1.82) (4.33) 0.08 0.05* 0.20 0.05* (6.17) (9.42) 0.02 0.03* 0.05 0.02* (2.56) (2.80) 1.49 0.52* 0.75 0.61* (2.33) (2.14) 0.14 0.19* 0.50 0.09* (2.99) (6.04) 0.07 0.14 0.29 0.08* (1.12) (1.95) Panel C. Unquoted companies 31.2 30.20 29.16 26.41 (-0.84) (0.96) 0.39* 2.75 1.86 0.05 (-1.94) (-1.17) 0.10 0.07 0.08 0.14 (1.04) (-0.45)
23
55.9 (-0.91) 0.06* (2.03) 0.15* (2.17)
20.39
29.35 (0.64) 0.09* (0.55) 0.24* (1.17) 0.13* (1.95) 0.02 (0.48) 0.001 (1.04) 0.35 (1.78) 0.06 (0.45) 0.02 (0.90) 1.06 (0.37) 0.08 (0.18) 0.06* (3.19)
20.88
33.3 (-1.09) 0.02* (3.46) 0.05* (3.52)
19.20
0.009 0.35
0.011 0.45 0.013 0.009 0.0005 0.32 0.03 0.02 0.31 0.04 0.06
0.003 0.13
17.7 (0.96) 0.005* (2.74) 0.25* (1.95) 20.25 (0.17) 0.05* (2.62) 0.31 (0.95) 0.013 (0.24) 0.001 (0.19) 0.003 (1.12) 0.29 (1.78) 0.02 (0.29) 0.02 (0.48) 0.29 (1.78) 0.03 (0.68) 0.05 (0.19) 12.0* (1.98) 0.003 (0.76) 0.11 (0.55)
Table 4. Growth differences between lessee and non-lessee companies The sample-firms is split into large (decile 10), medium-sized (decile 5) and small firms (decile 1) and into quoted and unquoted companies depending on whether the relevant company was trading on the London Stock Exchange at that particular time period. lessee firms are firms that reported Finance Lease and Hire Purchase in the Borrowing section in their Balance Sheet. Ad. OFTA are the additions to other tangible fixed assets (i.e., excluding property and buildings); Tax rec. is tax carry forward reported in the balance sheet; TA is total assets; ACTR is ACT recoverable; Tobin’s q is the ratio of market value to book value of equity. There are 26,479 total usable observations, 16,299 for quoted companies and 10,180 for unquoted companies. * significant at 0.01 level. ** Significant at 0.10 level.
All Companies Lessee
Nonlessee
Large Companies Lessee
Nonlessee
Medium-sized Companies Lessee
Nonlessee
Small Companies Lessee
Nonlessee
Panel A. All companies in the sample Ad. OTFA £m
21.2
Ad. OTFA/TA
6.139
R&D/Sales
2.20
Sales Growth
169
Ad. OTFA £m
27.10
Ad. OTFA/TA
6.64
R&D/Sales
2.77
Sales Growth
240
Payout ratio
49.70
Tobin’s q
3.63
Ad. OTFA £m
11.0
Ad. OTFA/TA
5.28
R&D/Sales
1.22
Sales Growth
47.8
57.0* 2.20 8.20* 160 (8.14) (9.58) 5.76 5.02 2.22* 3.33* (13.40) (28.92) 0.78 1.27 0.94 4.90 (0.91) (-0.83) 131.8 11.02 6.83* 137 (2.26) (0.27) Panel B. Quoted companies
1.30* (9.05) 3.43* (9.08) 0.27 (1.23) 39.4 (1.38)
0.214
69.60* 2.50 193.6 8.90* (7.21) (8.76) 6.40 2.51* 5.66 3.13* (12.13) (27.53) 1.19 1.07 1.50 8.60 (0.90) (-0.98) 118.3 7.32* 12.89 112 (2.15) (0.77) 34.79 90.40 50.77 52.40 (1.20) (0.21) 2.40 2.53 2.58* 2.28 (-0.72) (10.3) Panel C. Unquoted companies 73.9 1.80 7.2* 39.3* (3.85) (4.36) 3.39 1.79* 4.79 3.62* (11.15) (4.98) 0.18 0.55 0.59 0.72 (0.91) (1.17) 6.10 152 173 6.22 (0.82) (0.07)
1.25* (8.53) 3.27* (8.55) 0.40 (1.38) 27.60 (1.49) 48.17 (0.32) 2.01 (0.42)
0.23
1.40* (3.44) 3.65* (3.44) 0.16 (0.20) 54.20 (0.72)
0.18
24
6.56 11.64 165.2
6.90 12.03 214 15.83 9.90
5.72 10.7 47.9
0.117* (4.95) 3.43* (6.89) 37.60 (-0.96) 78.8 (0.99)
0.14* (3.34) 3.66* (5.56) 52.20 (-1.05) 105 (0.88) 23.67 (-1.61) 5.19* (6.91) 0.07* (5.45) 2.91* (4.22) 3.03 (0.93) 19.03 (1.13)
Table 5. Gearing differences between lessee and non-lessee companies The sample-firms is split into large (decile 10), medium-sized (decile 5) and small firms (decile 1) and into quoted and unquoted companies depending on whether the relevant company was trading on the London Stock Exchange at that particular time period. Lessee firms are firms that reported Finance Lease and Hire Purchase in the Borrowing section in their Balance Sheet. Gearing is the ratio of long-term debt to capital employed (long-term debt plus shareholders’ funds). BKL is for bank loans and overdraft. TD is total debt. There are 26,479 total usable observations, 16,299 for quoted companies and 10,180 for unquoted companies. * significant at 0.01 level. ** Significant at 0.10 level.
All Companies Lessee
Nonlessee
Large Companies Lessee
Nonlessee
Medium-sized Companies Lessee
Nonlessee
Small Companies Lessee
Nonlessee
Panel A. All companies in the sample Gearing
22.60
BKL/TD
56.69
Gearing
19.60
BKL/TD
57.91
Gearing
27.74
BKL/TD
54.58
12.20* 32.39 26.05* 21.80 (2.86) (2.03) 65.31* 40.74 34.21* 59.55 (-16.8) (4.64) Panel B. Quoted companies
13.19 (1.40) 71.52* (-7.55)
6.60
14.58 26.01 13.20* 32.72 (1.62) (2.13) 35.94* 60.49 63.81* 42.43 (3.96) (-8.99) Panel C. Unquoted companies
11.60 (1.02) 69.68 (-0.37)
5.90
32.50
15.20 (1.28) 73.71* (-6.61)
13.39
10.60* (2.18) 67.40* (-15.6)
31.54 36.39
26.12 (1.67) 31.21* (1.96)
25
58.17
50.24
49.99
50.84
9.78 (-0.76) 73.77* (-13.4)
8.27 (-0.76) 73.78* (-11.2)
13.17 (0.03) 73.74* (-7.26)
Table 6. Profitability differences between lessee and non-lessee companies The sample-firms is split into large (decile 10), medium-sized (decile 5) and small firms (decile 1) and into quoted and unquoted companies depending on whether the relevant company was trading on the London Stock Exchange at that particular time period. lessee firms are firms that reported Finance Lease and Hire Purchase in the Borrowing section in their Balance Sheet. PBIT is the profit before interest and tax; PBT is the profit before tax; ROE is return on equity, the ratio of earnings to shareholders funds; ROCE is the return on capital employed, the ratio of profit before interest and tax to long-term debt plus shareholders’ funds; EPS and DPS are earnings per share and dividend per share, respectively. There are 26,479 total usable observations, 16,299 for quoted companies and 10,180 for unquoted companies. * significant at 0.01 level. ** Significant at 0.10 level.
All Companies Lessee
Nonlessee
Large Companies Lessee
Nonlessee
Medium-sized Companies Lessee
Nonlessee
Small Companies Lessee
Nonlessee
Panel A. All companies in the sample PBIT £m
36.4
PBT £m
17.6
ROE
12.0
PBIT £m
48.16
PBT £m
26.70
ROE
13.10
EPS (p)
0.35
DPS (p)
0.105
Dividend Yield
3.05
PBIT £m
16.10
PBT £m
1.70
ROE
4.98
29.90* 299.0 231.0* 3.30 (2.19) (2.54) 160.0 0.36 9.70* 81.0* (4.06) (4.37) 25.15 12.46 9.20 12.85 (0.98) (1.49) Panel B. Quoted companies
3.10 (1.01) 3.70 (0.95) 6.79 (0.73)
0.001
250.0* 3.30 31.80* 362.0 (3.08) (3.71) 134.0* 0.61 15.10* 215 (3.18) (3.82) 14.18 14.56 22.91 7.60 (1.03) (1.59) 2.91 0.20 0.23 0.09 (1.48) (1.38) 0.11 0.63 0.05 0.13 (1.73) (1.36) 3.05 3.82 3.48* 3.05 (3.42) (0.01) Panel C. Unquoted companies
3.10* (2.36) 0.33** (1.87) 12.0* (1.99) 0.089 (1.42) 0.04 (1.76) 3.11* (-2.30)
-0.01
27.1* (-3.84) 1.50 (0.18) 3.90 (0.11)
3.10 (0.20) 8.04 (-1.00) 0.20 (0.62)
0.03
138.0 16.80 30.9
202.0* (-2.15) 3.10* (2.39) 10.12 (1.04)
26
3.10 -0.01 9.91
-0.038 -65.9
-0.05 -95.4 0.003 0.008 1.36
-0.01 4.60
0.21* (-2.12) -0.002 (-1.84) -21.5 (-1.17)
0.30* (-2.29) -0.005 (-1.60) -13.7 (-1.57) 0.05* (-3.51) 0.022* (-4.33) 2.49 (-1.79)
-0.001 (0.45) -0.003 (-1.30) -39.2 (1.28)
Table 7. Logit Regressions of the Probability of Using Leasing by All Companies in the 1982-1996 Periods Column 1 reports the result for the tax hypothesis. Column 2 is for the financing of growth potentials. Columns 3 and 4 are for size differences. Column 5 is for all the hypotheses. TAX/PBT is the ratio of tax charge to profit before tax; Tax rec is tax carry forward; TA is total assets; ACTR is the reported recoverable advanced corporate tax; Pr ACTR is the ACT recoverable provision; ACTWO is the ACT written off; ME is year end market value of equity; LTD is long-term debt; CE is capital employed; EPS is earnings per share; q is the ratio of market value to book value of equity; ln denotes the logarithm; SA is total sales; add. OFTA are the additions to other than property and building tangible fixed assets; Sales G is for sales growth; * and ** significant at 0.01 and 0.10 levels, respectively.
Constant Tax/PBT Tax rec/TA ACTR/ME
1 0.49* (155.2) -0.00 (-1.37) 1.13* (3.72) -
All Companies 2 3 4 0.509* 0.407* 0.235* (132.2) (23.24) (12.74) -
-
-
-
-
-
5 0.196* (10.6) -0.00 (-1.69) 2.65* (7.23) -
Pr ACTR/ME
-
-
-
-
-
ACTWO/ME
-
-
-
-
-
Add OFTA/TA
-
-
-
R&D/Sales
-
-
-
Sales G
-
-
-
q
-
0.711* (18.22) -0.00 (-0.14) 0.001 (0.83) -
-
-
0.71* (18.3) -0.00 (-0.15) 0.00 (0.02) -
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
0.002 (2.36) 0.004 (1.34) -
-
-
-
0.03* (17.2) -
-
-
-
0.03* (17.25) -
0.009* (4.67) -
-
-
-
0.1 23,411 22.63 0.00
1.3 22,225 297.7 0.00
2.9 22,225 86.92 0.00
0.3 14,306 10.42 0.00
2.1 13,210 72.46 0.00
0.1 14,306 21.85 0.00
0.007* (3.45) 0.1 13,210 11.94 0.00
-
-
-
-
EPS
-
-
-
-
ln(TA)
-
-
ln(Sales)
-
-
0.007* (4.76) -
ln(ME)
-
-
0.1 23,411 7.88 0.00
1.4 22,225 110.9 0.00
N F p-value
All Quoted Companies 2 3 4 0.53* 0.41* 0.43* (94.4) (18.9) (19.7) -
0.98* (16.3) 0.001 (0.15) 0.00 (0.23) 0.002* (3.67) -
LTD/CE
R2
1 0.50* (120.7) -0.00 (-1.40) 1.01* (3.16) 0.20* (1.96) 1.90* (5.68) 0.11 (0.46) -
*
-
-
5 0.11* (4.83) -0.00 (-1.12) 3.83* (7.07) -
1 0.47* (91.7) -0.00 (-0.80) 1.04 (1.03) -
0.90* (2.84) -
All Unquoted Companies 2 3 4 0.46* 0.41* 0.26* (76.8) (13.3) (7.92) -
-
-
-
-
-
5 0.24* (7.12) -0.00 (-1.06) 1.09 (1.04) -
-
-
-
-
-
-
-
-
-
-
0.84* (15.9) -0.00 (-0.22) 0.00 (0.05) 0.002* (3.77) 0.41* (17.5) 0.0003 (1.07) -
-
-
-
-
-
-
-
-
0.59* (8.74) -0.02 (-1.20) -0.00 (-0.79) -
-
-
0.58* (8.70) -0.03 (-1.62) -0.00 (-0.83) -
-
-
-
-
-
-
-
-
-
-
-
0.03* (15.1) -
-
-
0.006* (2.13) -
0.002* (1.98) -0.001 (-0.24) -
-
-
-
0.02* (6.71) -
0.02* (6.62) -
7.5 13,210 108.42 0.00
1.2 9,105 128.16 0.00
0.8 9,015 26.16 0.00
0.0 9,105 4.55 0.03
0.5 9,015 45.02 0.00
1.3 9,015 16.18 0.00
-
Table 8. Logit Regressions of the Probability of Using Leasing by Small Companies in the 1982-1996 Periods Column 1 reports the result for the tax hypothesis. Column 2 is for the financing of growth potentials. Columns 3 and 4 are for size differences. Column 5 is for all the hypotheses. TAX/PBT is the ratio of tax charge to profit before tax; Tax rec is tax carry forward; TA is total assets; ACTR is the reported recoverable advanced corporate tax; Pr ACTR is the ACT recoverable provision; ACTWO is the ACT written off; ME is year end market value of equity; LTD is long-term debt; CE is capital employed; EPS is earnings per share; q is the ratio of market value to book value of equity; ln denotes the logarithm; SA is total sales; add. OFTA are the additions to other than property and building tangible fixed assets; Sales G is for sales growth; * and ** significant at 0.01 and 0.10 levels, respectively.
Constant Tax/PBT Tax rec/TA ACTR/ME
1 0.42* (41.6) 0.00 (0.42) 0.40 (1.06) -
All Small Companies 2 3 4 0.45* -0.14 -0.02 (40.1) (-1.76) (-0.35) -
-
-
-
-
-
5 -0.05 (-0.95) -0.00 (-0.89) 1.30* (2.49) -
Pr ACTR/ME
-
-
-
-
-
ACTWO/ME
-
-
-
-
-
Add OFTA/TA
-
-
-
R&D/Sales
-
-
-
Sales G
-
-
-
q
-
0.39* (4.63) 0.001 (0.96) 0.00 (0.32) -
-
-
0.33* (4.07) -0.001 (-0.49) 0.00 (0.67) -
LTD/CE
-
-
-
-
EPS
-
-
-
-
ln(TA)
-
-
ln(Sales)
-
-
0.07* (7.25) -
ln(ME)
-
-
0.0 2,341 0.97 0.38
0.8 2,331 7.60 0.00
R2 N F p-value
1 0.43* (33.6) 0.00 (0.18) 0.33 (0.87) -1.91** (-1.73) -2.89 (-0.56) -0.11 (-0.08) -
All Small Quoted Companies 2 3 4 0.38* -0.14 0.07 (22.7) (-1.35) (0.85) -
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-0.001 (-0.44) -0.09* (-3.05) -
0.78* (5.14) 0.001 (0.82) 0.00 (0.08) 0.006* (6.03) -
-
-
-
0.06* (10.3) -
-
-
-
0.06* (10.2) -
0.07* (5.57) -
-
-
-
0.041* (4.16)
1.9 2,341 52.60 0.00
4.2 2,331 103.3 0.00
5.7 2,330 18.50 0.00
0.0 1,431 0.86 0.51
4.3 1,425 17.19 0.00
1.6 1,431 30.98 0.00
0.9 1,425 17.28 0.00
-
-
5 -0.24* (-3.4) -0.001 (-0.88) 0.58 (0.50) -4.24* (-3.72) 5.69 (0.97) -4.97* (-2.42) 0.66* (4.56) -0.001 (-0.77) 0.00 (0.31) 0.004* (3.62) 0.77* (9.27) -0.07** (-1.86) -
1 0.4* (21.7) 0.006** (1.84) 1.67 (0.53) -
All Small Unquoted Companies 2 3 4 5 0.43 -0.14 0.02 0.004 (20.8) (-1.13) (0.32) (0.06) 0.003 (0.95) 2.35 (0.56) -
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
0.48* (2.53) -0.03 (-1.58) 0.00 (0.69)
-
0.55* (2.87) -0.02 (-1.03) 0.00 (0.77) -
-
-
-
-
-
-
-
-
-
-
-
-
-
0.07 (8.54) -
-
-
0.07* (4.60) -
-0.00 (-0.00) -0.07 (-1.41) -
-
-
-
0.06* (5.61) -
0.06* (5.36) -
15.1 1,425 22.23 0.00
0.2 910 1.84 0.16
1.0 905 3.38 0.02
2.5 910 21.14 0.00
4.1 905 31.47 0.00
5.0 905 5.59 0.00
-
Table 9. Logit Regressions of the Probability of Using Leasing by Large Companies in the 1982-1996 Periods Column 1 reports the result for the tax hypothesis. Column 2 is for the financing of growth potentials. Columns 3 and 4 are for size differences. Column 5 is for all the hypotheses. TAX/PBT is the ratio of tax charge to profit before tax; Tax rec is tax carry forward; TA is total assets; ACTR is the reported recoverable advanced corporate tax; Pr ACTR is the ACT recoverable provision; ACTWO is the ACT written off; ME is year end market value of equity; LTD is long-term debt; CE is capital employed; EPS is earnings per share; q is the ratio of market value to book value of equity; ln denotes the logarithm; SA is total sales; add. OFTA are the additions to other than property and building tangible fixed assets; Sales G is for sales growth; * and ** significant at 0.01 and 0.10 levels, respectively.
Constant Tax/PBT Tax rec/TA ACTR/ME
1 0.48* (46.6) 0.00 (0.74) 6.13* (3.16) -
All Large Companies 2 3 4 0.57* 1.10* -0.21 (38.5) (8.55) (-1.42) -
-
-
-
-
-
5 -0.25 (-1.64) 0.00 (0.17) -0.05 (-0.03) -
1 0.52* (37.7) -0.00 (-0.21) 5.62* (2.70) 1.22* (2.25) 1.35* (2.66) 0.42 (1.04) -
All Large Quoted Companies 2 3 4 0.26* 0.54* 0.60* (2.08) (37.6) (30.4) -
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1.13* (5.26) -0.11 (-0.91) -0.00 (-0.07) -0.003 (-0.95) -
-
-
-
-
-
-
-
-
-
All Large Unquoted Companies 2 3 4 5 0.54* 1.61* -0.6* -0.61* (19.5) (7.09) (-2.09) (-2.14) 0.00 (0.42) -11.9** (-1.80) -
5 -0.30 (-1.59) -0.00 (-0.13) -0.38 (-0.19) -
1 0.40* (23.7) 0.00 (1.14) -2.26 (-0.41) -
0.86** (1.74) -
-
-
-
-
-
-
-
-
-
-
1.10* (5.18) -0.08 (-0.66) -0.00 (-0.31) -0.005 (-1.36) 0.54* (6.48) 0.07* (2.12) -
-
-
-
-
-
-
-
-
0.42 (0.93) 1.12 (0.93) -0.00** (-1.83) -
-
-
0.31 (0.83) 1.43 (1.20) -0.00** (-1.75) -
-
-
-
-
-
-
-
-
-
-
-
-
-
-0.08* (-5.33) -
0.015 (0.32) 0.003 (0.66) -
-
-
-
0.08* (3.99) -
0.08* (4.06) -
0.00 911 0.74 0.48
0.4 867 1.71 0.16
2.9 909 28.41 0.00
2.6 867 15.89 0.00
3.0 867 3.14 0.00
Pr ACTR/ME
-
-
-
-
-
ACTWO/ME
-
-
-
-
-
Add OFTA/TA
-
-
-
R&D/Sales
-
-
-
Sales G
-
-
-
q
-
1.01* (5.45) -0.10 (-0.80) -0.00 (-0.54) -
-
-
0.99* (5.34) -0.07 (-0.57) -0.00 (-0.12) -
LTD/CE
-
-
-
-
EPS
-
-
-
-
ln(TA)
-
-
-
ln(Sales)
-
-
-0.04* (-4.73) -
0.011 (1.03) 0.004 (0.87) -
-
-
-
0.06* (5.38) -
-
ln(ME)
0.06* (5.55) -
-0.03* (-2.50) -
-
-
-
R2 N F p-value
0.02* (2.54)
0.05* (4.07) -
0.3 2,341 5.27 0.00
1.4 2,292 10.09 0.00
0.8 2,341 22.41 0.00
1.6 2,292 30.78 0.00
2.8 2,292 7.73 0.00
0.9 1,431 4.12 0.00
0.3 1,425 6.44 0.00
0.3 1,431 6.44 0.01
1.9 1,425 7.21 0.00
6.1 1,425 9.42 0.00
-
