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

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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.

Suggested Citation

  • Annamaria Menichini & Maria Grazia Romano, 2018. "Does the Master’s Eye Fatten the Cattle? Maintenance and Care of Collateral under Purchase and Leasing Contracts," CSEF Working Papers 520, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 15 Mar 2021.
    • Handle: RePEc:sef:csefwp:520
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    References listed on IDEAS

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    More about this item

    Keywords

    Collateral; Financial constraints; Leasing; Maintenance.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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