Leases, debts and taxable capacity

Finance theory suggests that finance leases and corporate debt are substitutes, and that taxable capacity has a negative influence on leasing. There have been few tests of these predictions however. Previous work by Ang and Peterson, using US data, tested the prediction that finance leases and debt are inversely related, but ignored the prediction that the degree of leasing is negatively influenced by taxable capacity. Also, the results of the study were contradictory to the prediction of the theory, indicating that finance leases and debt complement each other empirically rather than acting as substitutes. In the present study, the two predictions stated above are tested, using data from a sample of UK quoted companies for the period 1990-92. The results indicate that, for a sub-sample of companies that use finance leases, the degree of leasing and debt financing are negatively related, as predicted by the theory. The results also support the suggestion that shortage of taxable capacity is an important explanation for leasing, and that inadequate access to the debt capital markets is another. We also find little evidence of an industry effect on the use of finance leases.