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The Role of Leasing under Adverse Selection

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  • Igal Hendel
  • Alessandro Lizzeri

Abstract

Leasing contracts specify a rental rate and an option price at which the used good can be bought at the termination of the lease. This option price cannot be controlled when the car is sold. We show that in a world with symmetric information this additional control variable is useless; equilibrium allocations and profits to lessors are unaffected by the option prices. In contrast, under adverse selection, leasing contracts affect equilibrium allocations in a way that matches observed behavior in the car market. We show that a social planner can use leasing contracts to improve welfare but they are imperfect tools; they cannot generally achieve first best while other mechanisms can. We also show that a producer with market power can benefit from leasing contracts for two reasons: better pricing of the option of keeping the used good, and market segmentation. Moreover, despite the fact that lessors could structure contracts to prevent adverse selection (by raising the option price so high that no lessee keeps the used good) we show that this is not in their interest; a keeping option will always be included in some contracts.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6577.

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Date of creation: May 1998
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Publication status: published as Hendel, Igal and Alessandro Lizzeri. "The Role Of Leasing Under Adverse Selection," Journal of Political Economy, 2002, v110(1,Feb), 113-143.
Handle: RePEc:nbr:nberwo:6577

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  1. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
  2. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, Elsevier, vol. 18(2), pages 301-317, August.
  3. Laffont, Jean-Jacques & Tirole, Jean, 1994. "Pollution Permits and Compliance Strategies," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 39, Institut d'Économie Industrielle (IDEI), Toulouse.
  4. Bulow, Jeremy, 1986. "An Economic Theory of Planned Obsolescence," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(4), pages 729-49, November.
  5. Preyas Desai & Devavrat Purohit, 1998. "Leasing and Selling: Optimal Marketing Strategies for a Durable Goods Firm," Management Science, INFORMS, INFORMS, vol. 44(11-Part-2), pages S19-S34, November.
  6. Smith, Clifford W, Jr & Wakeman, L MacDonald, 1985. " Determinants of Corporate Leasing Policy," Journal of Finance, American Finance Association, American Finance Association, vol. 40(3), pages 895-908, July.
  7. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 84(3), pages 488-500, August.
  8. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 38(3), pages 297-331, July.
  9. Steven A. Sharpe & Hien H. Nguyen, 1994. "Capital market imperfections and the incentive to lease," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 94-5, Board of Governors of the Federal Reserve System (U.S.).
  10. Grenadier, Steven R., 1996. "Leasing and credit risk," Journal of Financial Economics, Elsevier, Elsevier, vol. 42(3), pages 333-364, November.
  11. Waldman, Michael, 1997. "Eliminating the Market for Secondhand Goods: An Alternative Explanation for Leasing," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 40(1), pages 61-92, April.
  12. McConnell, John J. & Schallheim, James S., 1983. "Valuation of asset leasing contracts," Journal of Financial Economics, Elsevier, Elsevier, vol. 12(2), pages 237-261, August.
  13. Bond, Eric W. & Samuelson, Larry, 1987. "The Coase conjecture need not hold for durable good monopolies with depreciation," Economics Letters, Elsevier, Elsevier, vol. 24(1), pages 93-97.
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