Ryan J. Whitby

Do Leases Expand Debt Capacity

Theoretically and empirically, debt and leases have been shown to be both substitutes and complements. To explore the relation, we divide our sample into two subsets: those that exhibit a complementary relation (43% increase debt after increasing leases), and those that exhibit a substitutionary relation (57% decrease debt after increasing leases). For complement firms, we find a significant negative relation between leasing and the firms size, marginal tax rate, and z-score, consistent with “complementary” theories. For substitute firms, we find a positive and significant relation between leasing, the marginal tax rate and changes in cash. We also find a significant positive stock market reaction to the announcement of the SLB, which is stronger for the complement subset of firms.Most theoretical models predict that debt and leases should act as substitutes. While the preponderance of evidence supports this claim, there remain significant cases where debt and leases appear to be complements. One of the problems with prior research is that it is difficult to properly control for the changing asset base associated with leasing in cross-sectional tests. To overcome this problem, we examine a sample of sale-and-leaseback (SLB) transactions where the assets of the firm do not change due to the lease. We find evidence of a substitution effect between leases and long-term debt in our overall sample. We also find, however, that 40 percent of the firms exhibit evidence of a complementary relation by increasing their debt after the SLB transaction. To further explore this relation we divide the sample into two groups, those that show an increase in debt and those that show a decrease in debt after the SLB transaction. Within the substitute subgroup, leasing is associated with more capital expenditures and financial constraints. Within the complement subgroup, we find a significant relation between leasing and the firm’s marginal tax rate. The “leasing puzzle” first defined by Ang and Peterson (1984) remains unsolved. This puzzle involves the theoretical conjecture that debt and leases should act as substitutes (in the sense that more leases should lead to less debt), but Ang and Peterson found that firms that used more leases tended to have, in fact, more debt. A body of literature has developed since Ang and Peterson posed this puzzle, but no definitive answer has resulted. While the preponderance of evidence in the literature supports debt and leases as substitutes, there remain significant cases in which debt and leases simultaneously increase. One of the problems with the previous literature that examines this issue is the familiar ceteris paribus condition. But here the condition is more problematic because a typical lease involves the acquisition of the use of a new asset for the firm. In order to overcome this problem, we have chosen a sample of sale-and-leaseback (SLB) transactions in which the assets of the firm do not change due to the leasing transaction. Therefore, we can examine in detail the substitution or complement issue without the potential contamination of a change in the asset base or investments of the firm. The theoretical models in the leasing area have usually assumed that leases substitute for debt. The question posed in the model by Myers, Dill, and Bautista (1976) was how much debt is displaced by leasing. However, the leasing models presented by Lewis and Schallheim (1992) and Eisfeldt and Rampini (2007) do predict the possibility that debt and leases can be complements with theories based on taxes or bankruptcy costs, respectively. Therefore, the true nature of the relation between debt and leases remains an empirical issue. Bayliss and Diltz (1986), Marston and Harris (1988), Beattie, Goodacre, and Thomson (2000), and Yan (2006) all find that debt and leases are substitutes, with varying degree of substitutability. However, all of these studies suffer from the impact that new leases have on the 1 Other literature addressing the leasing puzzle includes Bayliss and Diltz (1986), Marston and Harris (1988), Beattie, Goodacre, and Thomson (2000), and Yan (2006). asset and investment opportunities of the firm. Our study will control for this problem with our sample of SLB transactions. Our results shed the following light on the leasing puzzle. First, in the overall sample of SLBs, we do not find any significant relation between the increase in leases and the change in total debt. However, when we examine just the changes in long-term debt and SLBs, we do find support of a substitution effect between the leases and debt. We then divide the sample of SLBs into two groups, those who show an increase in total debt, a little over 40 percent of the sample, and those that show a decrease in total debt. The first subgroup is labeled the complement sub-sample and the second group is the substitute subsample. For the substitute sub-sample, a dollar of SLBs appears to substitute for approximately

Gambling Preferences, Options Markets, and Volatility

0.37 of total debt. Examining just the long-term debt in the substitute sub-sample, a dollar of leases appears to substitute for approximately

Price Discovery in the Treasury‐Bill When‐Issued Market

0.78 of long-term debt. These findings are in line with the other studies of lease and debt substitution. We also examine the substitute sub-sample for the impact of asset changes, taxes, and financial constraints. We show that SLBs are associated with more capital expenditures and financial constrained firms. Marginal tax rates do not appear to be statistically correlated within this subgroup. To our knowledge, our study is the first to separate and examine a subgroup of leases that display the complement effect. Here we examine the impact of taxes and financial constraints as suggested by the Lewis and Schallheim (1992) and Eisfeldt and Rampini (2007) theories. According to our analysis of the complement sub-sample, the tax variable is significantly associated with the SLBs, but we do not find much support for an association with financial constraints for this subgroup. This paper is organized as follows. Section I describes the theoretical and empirical literature related to leasing and SLBs. Section II discusses our testable hypotheses. Section III describes our sample of SLB transactions and Section IV presents our results. We state our conclusions in Section V. I. Literature Related to Leasing and Sale-and-Leasebacks A. Leasing Theory Under the assumption of perfect capital markets, Modigliani and Miller show that the method of financing is irrelevant to the total value of the firm given the investment opportunity set. The notion that debt and leases are substitutes can be traced to the theoretical model of Myers, Dill and Bautista (MDB, 1976) who present a model of lease or buy (borrow). Even in the presence of corporate taxes, the choice between debt and leases can be irrelevant given common tax rates and no other market imperfections. In the MDB model, leasing can be advantageous to both parties of a transaction if the tax rates between lessor and lessee differ. The MDB model has a parameter, λ, that represents the substitution between debt and leases. The values for λ range between 0 and 1. In other words, the substitution between debt and leases may be dollar for dollar, or a dollar of leases may substitute for less than a dollar of debt. But MDB never consider the possibility that λ could be less than 0, i.e., that a lease could actually allow the firm to take on more debt. In other words, can leases and debt be complements? Two theories directly address the issue that leases and debt can be complements. Lewis and Schallheim (1992) present a tax-based model that demonstrates that debt and leases can be complements. The Lewis and Schallheim model allows for low tax paying firms to sell excess tax shields to firms that place a much higher value of these tax deductions. By removing 2 Interestingly, the common notion that a low tax rate firm benefits from leasing to a high tax rate firm is not unconditionally true. It is true under normal contracting terms, but it is possible to devise situations in which the opposite holds. However, the conditions for a high tax rate lessee benefiting from a low tax rate lessee are quite unusual and not likely to arise very often in practice. redundant tax shields, the lessee firm can be motivated to increase its proportion of debt relative to an otherwise identical firm that does not use leasing. Eisfeldt and Rampini (2007) provide another model for increased debt capacity due to leasing. The Eisfeldt and Rampini model is based on the repossession advantage of leasing to lessors who are willing to lease to more financially constrained firms. Counter-balancing this effect, however, is the agency costs of leasing due to the separation of ownership and control of the leased assets. The net advantage allows lessors to offer leases to more credit constrained firms who will then choose to lease more of their capital than less constrained firms. Thus debt and leases can be complements. There are other theories that relate to leasing, but do not directly address the substitute vs. complement issue. With regard to contracting theory, there is the issue of asset specificity. Klein, Crawford, and Alchian (1978) argue that assets with more firm specific uses are more likely to be owned (vertical integration) and more general-purpose assets are more likely to be leased. With regard to agency theory, there are the problems of over-investment (or asset substitution) and under-investment. Because leases are tied to a specific asset, leasing can help reduce the over-investment problem. There is also the issue of the separation of ownership and control with attendant agency issues as discussed in Smith and Wakeman (1985). Finally, the general implications of information costs are quite pervasive. However, much of the information-costs theories are related to the financial distress costs as incorporated by the Eisfeldt and Rampini (2007) theory. But there is one unique leasing feature related to information in that operating leases are a form of off-balance sheet financing by definition. From an economic point of view, it is unclear why off-balance sheet financing may be valuable, but firms certainly appear to be willing to undertake such transactions, even paying significant transaction costs to facilitate these leases (for example, synthetic leases). Two theory papers directly model the sale-and-leaseback contract. Kim, Lewellen, and McConnell (1978) show that SLB transactions can cause a wealth transfer from senior debtholders to stockholders. The reason for the wealth appropriation is the violation of me-first rules. In other words, senior debtholders would have had claim to the assets prior to their sale. After the

Human and Social Capital in the Labor Market for Directors

This study examines whether the gambling behavior of investors affects volume and volatility in financial markets. Focusing on the options market, we find that the ratio of call option volume relative to total option volume is greatest for stocks with return distributions that resemble lotteries. Consistent with the theoretical predictions of Stein (1987), we demonstrate that gambling-motivated trading in the options market influences future spot price volatility. These results not only identify a link between lottery preferences in the stock market and the options market, but they also suggest that lottery preferences can lead to destabilized stock prices.

Skewness, Short Interest, and the Efficiency of Stock Prices

When‐issued (i.e., forward) trading in T‐bills yet to be auctioned provides a unique environment for examining price discovery. Because T‐bills are auctioned in a sealed‐bid process, when‐issued traders cannot observe the spot market price. Yet the forward price must ultimately converge on the auction outcome price. Our results indicate that traders in the when‐issued market “discover” the ultimate auction price. Little evidence is found that standard order flow variables contribute to price discovery. Instead, the ability to observe a few trades with relatively small volume in the when‐issued market is sufficient to discover the auction price resulting from the sealed‐bid process.

Speculative Trading in Reits

Abstract Purpose This study examines the director labor market to better understand which director attributes are important for board service. Design/Methodology/Approach Director level data, which includes proxies for both human and social capital, is analyzed to determine which characteristics increase the likelihood of gaining additional board appointments. Findings We find that general skills and director connections are valued in the marketplace. Among specific director characteristics, financial expertise, holding an MBA degree, and S&P 500 experience are positively associated with gaining new board appointments. Moreover, regardless of the director’s level of expertise, highly connected individuals are more likely to obtain new appointments. Finally, from a range of characteristics, only director connections mitigate the negative consequences of serving on the boards of firms that restate their financials. Originality/Value While most research has analyzed the effectiveness of boards of directors as a whole, this study examines the value of individual director characteristics within the context of the labor market.

The information content of option ratios

We examine the association between return skewness, short interest and the efficiency of stock prices. Since preferences for skewness have been shown to impact asset prices, we examine how skewness relates to market efficiency. We find that stocks with positive skewness are less efficient, which might be explained by investor preferences for positive skewness. Next, we document that short interest reduces both total skewness and idiosyncratic skewness. Finally, while research has shown that short selling can improve the efficiency of markets generally, we show that short interest’s ability to improve market efficiency is strongest in stocks with the highest skewness.

The Distribution of REIT Liquidity

The role of speculative trading in markets is often debated. The recent extremes in the real estate economic cycle has created an ideal setting to investigate the role of speculative trading in the marketplace. Specifically, we focus on speculative trading in REITs during the recent boom and bust in real estate. While we find a strong relationship between speculative trading in REITs and the economic cycle, we do not find evidence that speculative trading is related to future returns. Increased speculative trading is apparent in REITs during the boom years, but the level of speculative trading in REITs is unrelated to the negative returns in REITs exhibited after the bust.

Idiosyncratic Kurtosis and Expected Returns

A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put–Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at all levels: daily, weekly, and monthly. While Pan and Poteshman (2006) show that signed P/C ratios, which require proprietary data, have predictive power, we find that unsigned P/C ratios, which do not require proprietary data, also have predictive power.

The impact of nominal stock price on ex-dividend price responses

In this study, we examine the distribution of market liquidity for a broad sample of Real Estate Investment Trusts (REITs). While prior research has focused on the average liquidity of REITs, we extend our analysis to include both the variability and skewness of liquidity, both of which have important implications. In extreme cases, excess variability in liquidity could present future uncertainty about the level of liquidity for REIT investors and the increased skewness of liquidity is indicative of increased competition among market makers. Our multivariate tests show that, consistent with prior literature, average bid-ask spreads are higher for the REITs than for non-REITs. We also find that the variability of bid-ask spreads is larger for REITs than for non-REITs. In addition, we find that the skewness of REIT bid-ask spreads has not only increased across time, but has also increased at a greater rate than the skewness of non-REIT spreads.