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Is Leasing A Substitute Or A
Complement Of Debt?
‘The Case Of Western European Transportation
Companies’
MASTER THESIS
BY
Zhenbei Xiao
Melis Stokestraat 102 5216 KR, Den Bosch The Netherlands Phone number: +31(6)14279800 Email: Z.Xiao.1@student.rug.nl Student number: s1730061-April 2010-
University of Groningen
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Is Leasing A Substitute Or A Complement Of Debt?
‘The Case Of Western European Transportation Companies’
Abstract
Leasing, as a rising financial funding possibility, is getting popular in these years. Companies can have more assets without adding extra debts in the balance sheet by using leasing. So some researchers think leasing and debt are substitutes. Leasing will use company’s debt capacity, so company will take less debt when they use leasing. However, the other theory comes later and suggests that leasing and debt are complements. When the company takes both debt and leasing, the company value will be maximized. Firms will take more debt when they use leasing. In this paper, 42 Western European transportation companies are studied to prove if leasing and debt are substitutes or complements.
JEL CODE: G32
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TABLE OF CONTENT
1. INTRODUCTION --- 4
2. LITERATURE REVIEW --- 6
2.1.1 Capital structure --- 6
2.1.2 Determinants of capital structure --- 8
- 4 - 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 95 96 97 98 99 00 01 02 03 04 05 06 07 0 50000 100000 150000 200000 250000 300000 350000 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 1. INTRODUCTION
The choice of the capital structure is one of the most important decisions made by the company’s management. It relates to how a company decides on its debt and equity. It is very popular for the company to finance the project by issuing debt. In particular, in a high corporate tax rate country, the firm can benefit from having more debt, because the debt can create a tax shield, which is a gain for the company and its shareholders. On the other side, equity issuing can be another possibility to finance the project. However, comparing to debt, issuing equity is considered to be more expensive. Besides the funding methods of debt and equity, leasing works as the third financing possibility nowadays.
Leaseurope, which is the European Federation of Leasing Company Associations, represents the leasing and automotive rental industries in Europe. In a press release of 2008, they reveal that ‘the portfolio of leased assets in Europe at the end of the 2008 is estimated to be in the region of 780 billion Euros, a 4.5% increase compared to the previous year.’ Since 1994, the total amount of leasing in Europe increased steadily. Figure 1 shows the total new leasing from 1994 to 2007. The highest growth rate of total new leasing reached 16.5% in 1999. Although the growth rate dropped to 2.7% in 2002, it has been caught up lately.
Figure 1: Total new leasing growth in Europe 1994 – 2007
In this figure, equipment production (left figure) and total new leasing growth rate from 1994 to 2007 can be found.
Source: http://www.leaseurope.org/index.php?page=key-facts-figures
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20%
7%
22%
37%
8%
6%
Comerical vehicles I T&Business machineMachiner y&i ndustrial equipment Passenger cars
Ships, trains, aircraft Other s
Leaseurope finds that the transportation sector leases 66% of the total volume of new equipment in 2008 (Figure 2). The transportation sector includes three types, which are i) ships, trains, aircraft; ii) passenger cars; iii) commercial vehicles. All of these three types can satisfy transportation needs of lessees. In the transportation industry, leasing plays an important role. For instance in the airline sector, companies rely on internal financing such as retained earning mostly. These retained earnings are used for purchasing new aircrafts or paying dividends to the shareholders. Meanwhile the price competition between the transportation companies is high and the company cannot easily increase the price to gain more retained earnings and so retained earnings are limited. A company then has to choose to buy new equipment to enlarge the business or to pay dividends to its shareholders. According to Cassell (1971), leasing can solve the problem. The company, especially the low profit one, can use leasing and still maintain its retained earnings for shareholders and other projects when expanding its business.
Figure 2 Percentage of new leased equipment volumes per asset type in 2008
Source: http://www.leaseurope.org/index.php?page=key-facts-figures
Because of the popularity of leasing in the transportation industry, firms may switch from debt or equity funding to leasing, which may reduce cost of owing and lower risk. When this happens, the capital structure of the company will be changed as well. According to Ross, Westerfield and Jaffee (1990), ‘If a firm leases, it will not use as much debt as it would otherwise.’ On the other hand, Lewis and Schallheim (1992) state that debt and leases can be complements and firms may use both debt and lease financing.
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transportation sector in Western European countries of leasing. So the research question of this paper is:
‘Is leasing a substitute or a complement of debt in the Western European transportation industry?’
In this paper, 42 transportation firms in Western Europe are studied. From the actual data description, the relationship between capital structure and leasing will be analyzed.
The rest of this paper is organized as follows: the second section presents the literature review with the capital structure theories and the determinants of the debt and capital structure. In this part, leasing theories and the relationship between leasing and capital structure are introduced too. The third section gives the methodology and the data description. Section four provides results and analyses the research results. In section five, the conclusion and recommendations are made.
2. LITERATURE REVIEW
2.1.1 Capital structure
Modigliani-Miller theory The Modigliani-Miller theorem (Modigliani and Miller, 1958) is the
first theory which proposes that the company’s debt-equity ratio is irrelevant to the company’s value. This theorem has two assumptions. One is absence of taxes; the other is no market frictions. However, the real world cannot avoid the elements mentioned above. Modigliani and Miller (1963) therefore address the existence of a tax advantage for debt financing. They indicate that the interest paid on the debt can be excluded from tax liability. As a consequence, additional use of debt instead of equity can generate a surplus known as ‘tax shield’.
Trade-off theory The trade-off theory suggests that the companies try to find an optimal capital
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Signaling theory Modigliani-Miller (1958) assumes that the market possesses full information
about the activities of firms. But when the managers possess inside information more than outside, the information is asymmetric. There are three famous signaling theories. The first one indicates that issuing equity dilutes current shareholders (Leland and Pyle, 1977). Selling shares to outside investors conveys unfavorable information and will result in a stock price decline. Second theory is Ross’s (1977) signaling theory, the company sends out positive signals to the less-informed by changing the capital structure. For example, if the company increases its debt, it is a positive sign for the market, because the management shows the market that the company is doing well so that it is able to bear additional debt. The last theory is distributing cash to the investor to reveal the firm’s earning capacity (Miller and Rock, 1985). Paying dividends or repurchasing the stock will be a positive sign for the market and results in a stock price increase.
Pecking order theory The pecking order theory states that the firm prefers to finance the
project by internal resource above external’s, and debt to equity if they issue securities (Myers, 1984). Internal funds do not have transaction cost and managers don’t need to worry about information leaking to outsiders. When it is necessary to fund from outside, the company will prefer debt issuing instead of equity. There are two reasons for managers to choose debt instead of equity. The first reason is that issuing debt is easier to be conducted. Managers can raise the same debt capital without the approval from the board of directors. In addition, issuing equity is more costly than debt. Secondly, issuing more equity conveys negative information to investors.
Agency theory In the agency theory, managers will not take the interests of the shareholders all
of the time into account. There are both conflicts between shareholders and company managers as well as between debt-holders and shareholders. These conflicts are especially severe in firms with large free cash flows—more cash than profitable investment opportunities (Jensen, 1986). In Harris and Raviv’s model, (1990), investors can gather information from the firm’s ability to make payments. Investors use such information about the firm’s prospects to decide whether to liquidate the firm or to continue current operations. Consequently, investors can infer better monitoring of the management of the company if the debt is higher.
Stakeholder theory A firm’s capital decision also depends on its non-financial stakeholders
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training (Grinblatt and Titman, 2002). They also suggest that the types of companies, mentioned above, have relatively less debt in their capital structures. The financial distress would also be less costly in firms which sell nondurable goods and services, and less specialized and if the quality can easily be assessed.
2.1.2 Determinants of capital structure
In previous studies, some determinants are defined by researchers which study the capital structure of the firm.
Size of the firm Size can be assumed as a proxy for low earnings volatility (Fama, French,
2002), the larger firms are, the more diversified and showing less volatility. According to Nunes and Serrasoueiro’s (2007), size has a positive impact on the debt ratio. Bigger firms are prepared to have more debts. According to the trade-off theory, a larger firm is willing to take relatively more debt. Also signaling theory suggests a positive relationship between size and the level of debt, because a larger firm is sending out a signal of vitality to the market if the company takes more debt. The pecking order theory predicts an inverse relationship between debt and size, if the firms have enough retained earnings to finance projects.
Profitability A firm with higher profitability has less financial stress. More profitable firms
have more income to shelter, and are in less danger of bankruptcy (Kjellman and Hansen, 1995). It means that the firm has less bankruptcy cost, so that the firm can benefit from debt deduction according to the trade-off theory. On the other hand, the signaling theory suggests a positive relationship between profitability and level of debt, because the firm who has a higher profitability with more growth opportunities is willing to take more debt and is able to pay the interest amortization relatively earlier. The pecking order theory indicates a negative relationship between profitability and debt, because a more profitable firm will have more retained earnings. Based on the principle of the pecking order theory, the firm will prefer internal financing instead of external.
Asset structure Asset structure can be measured in terms of assets tangibility. Based on the
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company due to more fixed assets. So when the proportion of fixed assets increases, the leverage is decreased. The asset structure might have a negative impact on debt.
Earning volatility According to the trade-off theory, the correlation between earning volatility
and debt level is a negative relationship. Because the company that has a higher level of earnings volatility is more likely to go bankrupt, it will use less debt (Marsh, 1982). On the other hand, signaling theory foresees a positive relationship between earning volatility and debt, because the company that has more debt is giving a positive signal to the market. In Nunes and Serrasoueiro’s (2007) research, they find out that there is a positive relationship between earning volatility and debt although it is less significant compared to other variables.
Growth opportunities Trade-off theory perceives that managers may ignore some high risk but
value creating projects to invest in order to maximize the benefit of the shareholders. Signaling theory shows a positive relationship between growth opportunities and the level of debt as well. Because it's a good sign for a company to take more debt, it means that the company has potential to grow by having more debt. The firm with a higher growth rate may use more internal funds to fund the new projects instead of the use of outside debt funding (Talberg, Winge, Frydenberg and Westgaard, 2008). According to the pecking order theory, growth opportunities have a positive impact on debt. Higher growth opportunities mean higher net income for the company, which implies that the company has more money to invest in new projects.
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Table 1: Summary of references for capital structure determinants
Five main capital structure determinants are proved by five different articles with different measurements and results.
Determinants Reference Measurement Result
Size of the firm 1)Chen (2003)
2)Jong,Kabir and Nguyen (2007) 3)Nunes and Serrasoueiro’s (2007) 4)Bhabra, Liu and Tirtiroglu(2008) 5)Crnigoj(2008)
1) Logarithm of total assets 2)Natural logarithm of total sales 3)Logarithm of total assets
4)Natural logarithm of annual sales revenues
5) Estimate of firm’s total sales
1) negative 2)negative 3)negative 4)positive 5)positive Profitability 1)Chen (2003)
2)Jong,Kabir and Nguyen (2007)
3)Nunes and Serrasoueiro’s (2007)
4)Bhabra, Liu and Tirtiroglu(2008)
5)Crnigoj(2008)
1)Ratio of earnings before interest, tax, and depreciation to total assets
2)Operating income over book value of total assets
3)Ratio between operating income and total assets
4)Ratio of operating income before depreciation over total assets
5)Operating margin – per cent by which sales price exceeds operating costs 1)negative 2)negative 3)positive 4)negative 5)negative
Asset structure 1)Chen (2003)
2)Jong,Kabir and Nguyen (2007) 3)Nunes and Serrasoueiro’s (2007) 4)Bhabra, Liu and Tirtiroglu(2008)
1)Ratio of tangible assets to total assets 2) Net fixed assets
3)Ratio between fixed assets and total assets
4)Ratio of fixed assets over total assets
1)positive 2)positive 3)negative 4)positive Earning volatility
3)Nunes and Serrasoueiro’s (2007) 3)Absolute value of percentage change of operating income 3)positive (not significant) Growth opportunity 1)Chen (2003)
2)Jong,Kabir and Nguyen (2007) 3)Nunes and Serrasoueiro’s (2007) 4)Bhabra, Liu and Tirtiroglu(2008) 5)Crnigoj(2008)
1)Sales growth/total asset growth
2)Market value of total assets over book value of total assets 3)Growth of total assets
4)Tobin’s q1
5)Change of sales over the last 3 years
1)positive 2)negative 3)positive (not significant) 4)negative 5)positive 1
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Recently, besides the conventional financing channels, the development of lease financing has become relevant. A lease can be defined as ‘a contractual arrangement by means of which the use of a fixed asset is transferred for a restricted period by its owner to a potential user, while its title is retained by the former.’ (Eiteman, Davisson, 1951) Originally, a lease contract was used for leasing land and buildings. Nowadays, leasing is also used frequently for the transportation sector, such as leasing aircrafts, trucks, trains etc.
Prevailing finance theories mention that the biggest motivation for leasing originates from tax advantages. When the company has more debt, and if it is in a high corporate tax rate country, an important tax shield will be created. Debt tax shield is the present value of the debt-interest deduction for all corporate profits taxes: federal, state, and city. Grinblatt and Titman (2002) calculate the leasing cost and owning cost for different tax rates, and find out that the low tax bracket investors may often choose leasing above buying, because leasing for them is cheaper than buying.
Furthermore, leasing can also reduce a company’s bankruptcy cost in comparison to using ordinary debts, because leasing can make the equipments available without the appearance of more debt in a company’s balance sheet.
Bower, Herringer and Williamson (1966) distinguish the advantages of leasing in three groups. The first one comprises the advantages pertaining to basic cash flows. The firm can conserve the cash and capitals to invest in other activities instead of paying for a new machine. Moreover, the maintenance cost of the new machine and property tax can be saved. Secondly, there are advantages pertaining to the uncertainties of basic cash flows which can be called risk advantages. Leasing can reduce the risk in comparison to having a new machine. Also the obsolescence of the idle machine can be diminished. Thirdly, there are advantages of pertaining the financial advantages in terms of priority claims on the basic cash flow as leasing does not add more debt on a balance sheet.
2.2.2 Determinants of leasing
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to use the equipment, but doesn’t want to buy, they can use the operating lease. The lessee pays the rent for using the equipment until the end of the lease contract. The sum of the payments for the lease is generally less than the purchase price of the equipment, and in the end, the lessor is therefore also still the owner of the equipment. The lease payments of operating leasing are charged to the income statement on a straight-line basis as they are operating expenses normally.
The other type of lease is called financial lease or capital lease. Financial lease is an agreement that generally extends over the life of the asset and indicates that the lessee cannot return the asset except with substantial penalties (Grinblatt and Titman, 2002). In a financial lease, the lessee generally becomes the owner of the equipment at the end of the lease contract. The lease contract period is extended to the equipment’s useful life. The financial leases can be treated as a liability. Most companies use financial lease as a third financing channel. It can be divided into non-current interest-bearing liabilities and current interest-bearing liabilities. A company probably will use less debt and displace by financial leasing.
Tax will be another important element to be considered in the leasing decision. Leasing provides opportunities for lessees to ‘sell’ its unused non-debt tax shield to lessor to decrease the lease payment. In operating leasing, the lease payment is written as operating expenses which is tax deductable. With financial leasing, the interest of financial leasing is tax deductable. On the other hand, if the firm operates under a high tax country, it can benefit more from debt tax shield.
The interest rate can be another element when the company decides to lease or not. If the interest rate on financial leasing is lower than loans, the company will be attracted to lease more instead of borrowing more money from bank.
2.3 Debt V.S leasing
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Second, the risk of using debt is less than that equity. Because of the expensiveness of equity issuing, it is costly for both large and small firms. Especially for the small firm issuing equity for the first time, it is risky for the firm and difficult to price the shares. Moreover, since the company has to go public, the information about the company will be revealed to its competitors. Third, companies can take tax advantages by having more debt. In a high corporate tax rate country, companies can diminish the tax payment by taking more debt. Because interests are a tax deductable item, the more interest the company pays, the less tax payment for the company. However, leasing as a rising funding channel appears. Management may choose the funding method between debt and leasing instead of debt and equity.
There are two types of relationships between debt and leasing. Some researchers think leasing is the substitute of debt, in others opinion, debt and leasing are complements.
First, Myers, Dill and Bautista (1976), use a formula to value the leasing contract. In their opinion, the lease displaces debt, so it occupies some of the firm’s debt capacity. Because when the company signs a lease contract, it will reduce its ability to borrow through other channels. The amount of debt displaced by the lease depends on the value of the lease’s liability. Simultaneously, the value of the lease’s liability also depends on the amount of debt displaced. When a lessee is offered favorable terms, in which the net present value of the leasing contract is greater than zero, the firm assumes a relative small liability by signing the contract. The smaller the lease liability, the more the firm will be able to borrow through conventional channels. On the other side, if a lessee is offered unfavorable terms, in which the net present value of the leasing contract is less than zero, the firm assumes a relative large lease liability and relative less conventional borrowing will result. The firm will then prefer to borrow money and to have more debt.
Then, Beattie, Goodacre and Thomson (2000) do empirical research to prove that debt and leasing are substitutes. This study estimates the total liability in terms of operating leases at the individual company level and incorporates this with the finance lease liability in a comprehensive measure of leasing. The results of their research imply that leasing and debt are partial substitutes, with 1 pound of leasing displacing around 0.23 pound of non-lease debt on average. Their funding suggests that substitution effects are not uniform across lease types.
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the opportunity for a lessee to transfer the non-debt tax shields such as depreciation to the lessor. As non-debt tax shields are sold, lessee’s potential of debt deductions is reduced and the marginal value of debt becomes positive. The lessee responses to this incentive by issuing additional debt. This can be realized even if the lessee and lessor have identical marginal tax rates. They also demonstrate an example based on DeAngelo and Masulis’ (1980) capital structure model. The example reveals that the different proportions of leasing (0%, 50% and 100%) affect a firm’s value under different optimal debt levels. Three conclusions of the sample confirm that: first the firm value can be maximized by using combinations of debt and leasing. Second, leasing can be advantageous in perfectly competitive markets when both lessee and lessor have identical marginal tax rates. Third is that the interaction of debt and leasing can induce the lessee firm to increase the optimal amount of debt relative to the no-leasing option.
In my research, I will assess if leasing and debt are substitutes or complements in the transportation industry.
3. METHODOLOGY
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Figure 3 Conceptual model with dependent variable, independent variables and control variables.
As I show in the Figure 3, the dependent variable is the non-leasing debt ratio, which is non-leasing debt divided by total assets. This debt to asset ratio presents the company’s debt structure. In order to see the relationship between debt and leasing more clearly, I use for debt the non-leasing debt ratio which is debt minus leasing.
The main independent variables are financial lease and operating lease. Within financial leases are non-current leasing and current leasing distinguished. Non-current financial leasing stands for the financial lease which is longer than 5 years, and current financial leasing is the financial lease which ends within 5 years. Although some companies divide operating leases in current operating leases and non-current operating leases as well, I treat operating lease as one unit because most companies do not provide detailed information about current or non-current operating leasing.
Second, I make hypotheses to test if the leasing variables have a direct impact on the dependent variable of non-leasing debt. In addition, I will test current financial leasing and non-current financial leasing instead of financial leasing to test if the results differ.
The hypotheses are as follows:
Ha: Ha0=Financial leasing has no effect on non-leasing debt
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Hb: Hb0=Current financial leasing and non-current financial leasing have no effect on
non-leasing debt
Hb1=Current financial leasing and non-current financial leasing have an effect on
non-leasing debt
Hc: Hc0=Operating leasing has no effect on non-leasing debt
Hc1=Operating leasing has an effect on non-leasing debt
Third, I will test for the control variables if they impact leasing debt related to leasing. In these tests, I will study if the magnitudes of the various variables influence leasing, so I will compare leasing in the high profit group and in the low profit group; in bigger size firms and smaller firms, etc.
These variables are chosen by other researchers in previous studies as they are assumed to influence the debt structure in the company.
Table 2 presents the measurement of these control variables in below:
Table 2 Measurement of the control variables
Control variables Measurement
Size Log of total assets
Profitability Operating income divided by total assets Asset structure Fixed assets divided by total assets.
Earning volatility Standard deviation of profit divided by total assets of 2007-2008: s=
x=after tax profit divided by total asset Growth opportunity Growth rate of total assets
Tax rate Official country corporate income tax rate
Interest rate Company leasing interest rate
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leasing and operating leasing. The second model is regression with current financial leasing, non-current financial leasing and operating leasing. The reason I separate the regression into two models is that I like to study if there is any difference by using financial leasing in general and separately. Furthermore, I will also run the regressions by business categories, such as ‘Airline’, and ‘Vessel’ and etc. Based on above variables, I estimate the equations as follow:
Model I:
DNLi1=0+1FLi+2OLi+3Sizei+4Profiti+5ASi+6EVi+7GOi+8Taxi+9Ii+i (1)
Model II:
DNLi2=0+1 CFLi+2NCFLi+3OLi+4Sizei+5Profiti+6ASi+7EVi+8GOi+
9Taxi+10Ii+i (2)
Where DNL is non-leasing debt ratio FL is financial leasing
OL is operating leasing Size is firm size
Profit is profitability AS is asset structure
EV is earning volatility GO is growth opportunity
Tax is tax rate I is interest rate
CFL is current financial leasing NCFL is non-current financial leasing
All company specific data are picked from company’s annual report from 2007 to 2008. The financial leasing data are collected from company balance sheets or notes. Because companies separate financial leasing into current financial leasing and non-current financial leasing, I add them together to get financial leasing in general which I also use separately.
4. DATA
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in Western Europe these days. The second criteria is ‘Industry’, I pick the categories from NAICS 2007 (North American Industry Classification System). More specifically, the company’s main business is air, rail, water or truck transportation. The last criterion is whether the company is listed on the stock exchange. Because the listed companies have English annual reports, I select only listed companies. By combining these three criteria, I got 89 companies in total. After I looked into the data, there are 42 companies which have adequate data for this research.
These 42 companies are located in 14 different countries. Fourteen companies are located in Norway, which is the highest percentage of all countries. The second highest one is the UK, which has 7 companies involved in this research. But due to too many countries involved in the sample, I am not going deeper into the distinction of countries in this research. However in this paper, the sample companies can also be divided into three business categories, which are ‘Airlines’, ‘Vessel’, and ‘Others’. The Airline companies are companies such as Ryanair and Finnair. The vessel companies are offering boat services for goods or passengers. The remaining companies offer auto or truck transportation or marine service etc. In these three categories, ‘Vessel’ is the biggest one, which has 24 companies operating in it. There are 11 ‘Airline’ companies, and the remaining 7 companies belong to ‘Others’.
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Table 3 Descriptive statistics of all variables in General
/ Variables N Minimum Maximum Mean Median
Financial leasing 42 .00 .28 .04 .01
Current financial leasing 42 .00 .12 .01 .00
Non-current financial leasing 42 .00 .25 .03 .00
Operating leasing 42 .00 .92 .25 .10
Non-leasing debt (non-leasing debt/total assets)
42 .17 .94 .60 .61
Size (Log of size) 42 1.90 8.82 5.66 6.25
Profitability (Operating income/total assets)
42 -.19 .38 .05 .06
Asset structure (Fixed asset/total assets)
42 .00 .88 .56 .60
Earning volatility (Standard deviation of after tax profit)
42 .00 .21 .05 .03
Growth opportunity (Growth rate of total assets)
42 -22.81 47.79 7.90 8.98
Country corporate tax rate 42 10.00 33.99 25.11 28.00
Leasing interest rate 42 2.63 9.79 5.26 5.25
From table 3, the mean of financial leasing ratio is 0.04, and mean of operating leasing ratio is 0.25. It shows us that companies use relatively more operating leasing than financial leasing. In financial leasing, non-current financial leasing ratio (0.03) is higher than current financial leasing (0.01). However, compare to the non-leasing debt ratio, leasing is not as important as debt in the sample companies.
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Table 4 Descriptive statistics of all variables in different groups
/ Airline+Other Vessel
/ Variables N Min Max Mean Median N Min Max Mean Media
n Financial leasing/Total assets 18 .00 .28 .08 0.03 24 0.00 0.18 0.03 0.00 Current financial leasing/Total assets 18 .00 .12 .02 0.01 24 0.00 0.11 0.01 0.00 Non-current financial leasing/Total assets 18 .00 .25 .06 0.01 24 0.00 0.04 0.02 0.00 Operating leasing/Total assets 18 .00 .69 .15 0.07 24 0.00 0.92 0.33 0.25 Non-leasing debt (non-leasing debt/total assets) 18 .36 .94 .63 0.63 24 0.17 0.83 0.58 0.59
Size (Log of total assets) 18 2.58 8.82 5.62 5.91 24 1.90 7.48 5.69 6.34 Profitability (Operating income/total assets) 18 -.19 .15 .03 0.04 24 -0.15 0.38 0.07 0.07 Asset structure (Fixed asset/total assets) 18 .00 .88 .55 0.67 24 0.17 0.87 0.57 0.58 Earning volatility (Standard deviation of after tax profit/total assets) 18 .00 .18 .04 0.02 24 0.00 0.21 0.06 0.05 Growth opportunity (Growth rate of total assets) 18 -22.81 47.79 9.44 11.34 24 -19.48 41.19 6.74 7.44 Country corporate tax rate 18 10.00 30.00 23.25 27.00 24 12.50 33.99 26.50 28.00
Leasing interest rate 18 2.63 8.00 5.03 4.95 24 3.96 9.79 5.43 5.50
From table 4, it is obviously to see that the group ‘Airline+Other’ has more leasing than the group ‘Vessel’. The mean of either financial leasing or operating leasing in the ‘Airline+Other’ group is higher than the ‘Vessel’ group. And the group ‘Airline+Other’ also takes more non-leasing debt than the ‘Vessel’ group. The size of the ‘Vessel’ group is bigger than the ‘Airline+Other’, and it also has more fixed assets.
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Around 64% of the companies have non-current financial leasing and 62% have current financial leasing.
Table 5 Leasing description for each group
Groups No. of Current
financial lease No. of Non-Current financial lease No. of Operating lease Total number of company in each group Airline+other 15 (83%) 15 (83%) 18 (100%) 18 Vessel 11 (46%) 12 (50%) 22 (92%) 24 Total 26 (62%) 27 (64%) 40 (95%) 42
From Table 5 we can see that most companies have at least 83% either in financial leasing or operating leasing in the categories both ‘Airline+Other’. In the category ‘Vessel’, there are only 46% of the companies which have current financial leasing, and 50% have non-current financial leasing. Meanwhile there are 2 companies which don't have operating leasing. In general, the companies in categories of ‘Airline+Other’ use more leases than Vessel companies. Especially in operating leasing, ‘Airline+Other’ reach 100% of the usages. The ‘Airline+Other’ group has more financial leasing compare to ‘Vessel’. On the other hand, the ‘Vessel’ group has more operating leasing.
In this research, I find out that in the real world, leasing is not as important as I expected in the transportation industry. Although around 95% of the companies at least have operating leasing in the company, the amount of leasing is a small part compared to the company’s total assets. In addition, leasing, more specific, the financial leasing is a part of debt. The data of financial leasing are collected from ‘Loans and borrowings’ under the ‘Non-Current liabilities’ or ‘Current liabilities’ in the balance sheets of the sample companies. The ‘Loans and borrowing’ consists of ‘financial lease’, ‘bank loans’, and ‘other loans’ in general.
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Table 6 Hypotheses tests with respect to the non-leasing debt ratio
In this table, the tests examine if the variables influence non-leasing debts. As cut point of each variable, the means are used.
Variables Cut point Numbers Mean Sig. Accept Hypotheses
>=0.04 13 0.5908
Financial leasing
<0.04 29 0.6076
0.633 Do not reject Ha0
>=0.01 15 0.6453
Current financial leasing
<0.01 27 0.5785
0.139 Do not reject Hb0
>=0.03 12 0.6117
Non-current financial leasing
<0.03 30 0.5987 0.784 Do not reject Hb0 >=0.25 16 0.5812 Operating leasing <0.25 26 0.6154 0.528 Do not reject Hc0
In the independent T-test, I set the cut point as the mean of each variable to test if these variables have influence on non-leasing debt. I do not use median as a cut point because the median of current financial leasing and non-financial leasing are zero. From the results above we can see that the significant level of each variable is bigger than 0.05. So I conclude that the null hypotheses for three hypotheses which I made in previous chapter are not rejected. Financial leasing, current and non-current financial leasing, and operating leasing have no influence on non-leasing debt in this research.
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Table 7 Influences of variables on leasing
In this table all variables (includes dependent variable and control variables) are tested if they have influence on financial leasing or operating leasing. As cut point of each variable, the medians are used.
Financial leasing Operating leasing Variables Cut point No. Mean Sig. Mean Sig.
>=0.61 21 0.0390 0.2533
Non-leasing debt (debt without
leasing/total assets) <0.61 21 0.0562
0.055
0.2529
0.511
>=6.25 21 0.0490 0.2315
Size (Log of size)
<6.25 21 0.0462
0.417
0.2748
0.311
Profitability >=0.06 22 0.0382 0.2401
(Operating income/total assets) <0.06 20 0.0580
0.208
0.2675
0.903
Asset structure >=0.60 21 0.0514 0.1863
(Fixed asset/total assets) <0.60 21 0.0438
0.970
0.3200
0.026
Earning volatility >=0.03 23 0.0596 0.3022
(Standard deviation of after tax profit/total assets) <0.03 19 0.0332 0.015 0.1938 0.031 Growth opportunity >=8.98 21 0.0500 0.2548
(Growth rate of total assets) <8.98 21 0.0452
0.804 0.2514 0.350 Corporate tax >=28% 24 0.0433 0.2358 <28% 18 0.0533 0.507 0.2762 0.806
Leasing interest rate >=5.25 21 0.0248 0.000 0.2487 0.750
<5.25 21 0.0705 0.2576
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The last test in my research is the regression analysis. I make two regressions with two models. The model I is a regression with both financial leasing and operating leasing. The model II is a regression using current financial leasing and non-current financial leasing instead of financial leasing. Furthermore, I also make these two types regressions in different business categories to see if there are any differences within the industry. Because the sample size of categories ‘Airline’ and ‘Other’ is too small to test, I add them together in the category ‘Airline’. So there are two different groups involved in the regression test. Group one is ‘Airline+Other’, group two is ‘Vessel’. The results of both regressions are presented in following tables.
Table 8 General regression summary
In this table, the relationships between variables and non-leasing debt are presented with the significant for two different models.
Variables Model I Model II
Financial leasing -0.052
(0.866)
Current financial leasing 0.133
(0.871)
Non-current financial leasing 0.840
(0.057)
Operating leasing -0.082 -0.095
(0.353) (0.244)
Size (Log of size) -0.022 -0.023
(0.143) (0.102)
Profitability (Operating income/total assets) 0.545 0.724
(0.025) (0.005)
Asset structure (Fixed asset/total assets) -0.055 -0.074
(0.593) (0.445)
Earning volatility (Standard deviation of after tax profit)
-0.590 (0.141)
-0.368 (0.343)
Growth opportunity (Growth rate of total assets) -0.003 -0.002
(0.076) (0.121)
Country corporate tax rate 0.002 -0.001
(0.663) (0.799)
Leasing interest rate 0.000 0.009
(0.986) (0.658)
(Constant) 0.755 0.747
(0.000) (0.000)
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In above regressions, there is a significant relationship found in Model II for non-current financial leasing. Profitability has significant results in both models. There are no significant relationships found for the rest of variables.
Then I make the regressions in different business groups. The group results are presented in the next table.
Table 9 Group regression summary
In this table, the relationships between variables and non-leasing debt are presented with the significant for two different models in ‘Airline+Other’ and ‘Vessel’ group individually.
Airline+Other Vessel
Variables Model I Model II Model I Model II
Financial leasing -0.516 0.682
(0.281) (0.311)
Current financial leasing 0.683 0.288
(0.574) (0.887)
Non-current financial leasing -0.744
(0.425)
0.403 (0.904)
Operating leasing 0.345 0.572 0.682 -0.192
(0.111) (0.062) (0.060) (0.128)
Size (Log of size) 0.008 -0.002 -0.028 -0.029
(0.767) (0.947) (0.187) (0.269)
Profitability (Operating income/total assets) -0.435 (0.454) -0.624 (0.422) 0.729 (0.019) 0.841 (0.019)
Asset structure (Fixed asset/total assets) -0.215 (0.252) -0.127 (0.512) -0.206 (0.252) -0.147 (0.413) Earning volatility (Standard deviation
of after tax profit)
-0.896 (0.363) -1.373 (0.216) -0.584 (0.238) -0.475 (0.457) Growth opportunity (Growth rate of
total assets) -0.001 (0.786) -0.001 (0.890) -0.003 (0.186) -0.003 (0.313) Country corporate tax rate -0.008
(0.308) -0.004 (0.701) 0.001 (0.894) 0.001 (0.862)
Leasing interest rate 0.023 0.027 -0.007 -0.002
(0.541) (0.551) (0.782) (0.937)
(Constant) 0.816 0.675 0.938 0.856
(0.007) (0.039) (0.003) (0.011)
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In group regression tests, a significant positive relationship is found for operating leasing in both groups. Profitability shows a significant positive influence on non-leasing debt in the ‘Vessel’ group for both models. There is no other significant relationship found in the rest of the variables.
5. FINDINGS
In this research, although the results are not as expectation, there still are some significant results found. I summarize these results in Table 10.
Table 10 Regression analysis summary
This table summarizes main results can be found from the regression analysis presented in previous chapter.
/ General Airline+Other Vessel
/ Variables M I M II M I M II M I M II
Non-current financial leasing +
Operating leasing + +
Profitability (Operating
income/total assets) + + + +
First, the non-current financial leasing shows a positive relationship in the general regression in Model II. This proves the theory from Lewis and Schallheim (1992), which is that leasing and debt are complements. If companies use more non-current financial leasing, the debt will increase as well. Lewis and Schallheim (1992) also mention that debt and leasing can be complements even if the lessee and lessor have identical marginal tax rate. In this research, I don’t find significant relationships between country corporate tax rate and non-leasing debt. This thus confirms that tax is not a main attraction for companies to take leasing instead of debt.
Second, the positive relationship between operating leasing and non-leasing debt is found in both group regressions. This finding supports Lewis and Schallheim (1992)’s theory again. When the companies take more operating leasing, they will also take more debt.
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Profitability In both general and group regressions, profitability is found to give a positive
relationship with non-leasing debt. Especially in the ‘Vessel’ group, it has high significance. According to signaling theory, higher profit companies take more debts, because companies have confidence to repay debts, and it’s a positive sign for outside investors.
No significant results found for the rest of the variables in this research.
6. CONDLUSION
Besides debt and equity financing, leasing becomes a popular topic in the capital structure decision. Companies can take advantages from leasing. For example, companies can acquire the fixed assets by leasing without adding new debt on the balance sheet. Or companies can just have operating leasing of assets in order to save on cost of maintenance and obsolescence of the idle machine.
As leasing is a relevant issue in the West-European transportation industry, I asked myself the following question: ‘Is leasing a substitute or a complement of debt in the Western European
transportation industry?’In theory, leasing and debt have positive and negative relationships.
On one hand, the lease displaces debt, so it occupies some of the firm’s debt capacity, so leasing and debt have a substitution relationship. On the other hand, researchers think that firm value can be maximized by using a combination of debt and leasing, and the lessee will be motivated to increase debt in comparison to a no-leasing option. For that case, leasing and debt have a complementary relationship. In this research, only positive relationships are found, either in financial leasing or operating leasing. Therefore, I conclude that leasing is not a substitute for the non-leasing debt ratio, but a complement.
Furthermore, companies in the transportation industry do not use as much leasing as expected. As I showed in the data descriptive, leasing occupies a small part of the companies’ total assets. Operating leasing is only 25% of the total assets. Financial leasing is even less with 4% only. Non-leasing debt represents 60% of the total assets. So compared to debt, leasing is not used frequently. Moreover, I find out that non-leasing debt, asset structure, earning volatility and leasing interest rate all have significant effects on either financial leasing or operating leasing.
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The results of this research may arise to the some extent from sample selection. Due to the lack of information on non-listed companies, the observation companies are all listed. According to former researchers, the listed or bigger companies need less leasing than smaller companies. That’s why I may have found out that leasing is not really important in my research. For further research, I suggest choosing small companies or mix companies of various sizes instead of listed companies only. Second, the number of observation is small. In my research, there are only 42 companies involved. The number in the sample is not enough for regression tests for various subgroups. For example, I don’t have sufficient numbers of samples to dig deeper in the direction of country of original. In my regression test, the sample size of ‘Other’ group is also too small to analyse. Moreover, the most of the observation companies come from Norway and the main sector in my research consist of ‘Vessel’ companies. The unequal distribution of companies over countries and subsectors may have distorted the results. Therefore I suggest further research to choose the sector equally and have more observation companies. The last finding is that the control variables are not too relevant for the non-leasing debt ratio. So in further research I suggest the researcher to select also other control variables to test.
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