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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.

Suggested Citation

  • Igal Hendel & Alessandro Lizzeri, 1998. "The Role of Leasing under Adverse Selection," NBER Working Papers 6577, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6577
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    References listed on IDEAS

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    1. Laffont, Jean-Jacques & Tirole, Jean, 1996. "Pollution permits and compliance strategies," Journal of Public Economics, Elsevier, vol. 62(1-2), pages 85-125, October.
    2. Bond, Eric W. & Samuelson, Larry, 1987. "The Coase conjecture need not hold for durable good monopolies with depreciation," Economics Letters, Elsevier, vol. 24(1), pages 93-97.
    3. Sharpe, Steven A. & Nguyen, Hien H., 1995. "Capital market imperfections and the incentive to lease," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 271-294.
    4. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    5. Grenadier, Steven R., 1996. "Leasing and credit risk," Journal of Financial Economics, Elsevier, vol. 42(3), pages 333-364, November.
    6. Alessandro Lizzeri & Igal Hendel, 1999. "Adverse Selection in Durable Goods Markets," American Economic Review, American Economic Association, vol. 89(5), pages 1097-1115, December.
    7. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    8. McConnell, John J. & Schallheim, James S., 1983. "Valuation of asset leasing contracts," Journal of Financial Economics, Elsevier, vol. 12(2), pages 237-261, August.
    9. Jeremy Bulow, 1986. "An Economic Theory of Planned Obsolescence," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 729-749.
    10. Waldman, Michael, 1997. "Eliminating the Market for Secondhand Goods: An Alternative Explanation for Leasing," Journal of Law and Economics, University of Chicago Press, vol. 40(1), pages 61-92, April.
    11. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    12. Preyas Desai & Devavrat Purohit, 1998. "Leasing and Selling: Optimal Marketing Strategies for a Durable Goods Firm," Management Science, INFORMS, vol. 44(11-Part-2), pages 19-34, November.
    13. Smith, Clifford W, Jr & Wakeman, L MacDonald, 1985. " Determinants of Corporate Leasing Policy," Journal of Finance, American Finance Association, vol. 40(3), pages 895-908, July.
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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