Lease Valuation When Taxable Earnings Are a Scarce Resource




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    • Franks is a National Westminster Bank Professor of Finance, London Business School, and a Visiting Professor at UCLA. Hodges is an Esmee Fairbairn Professor of Financial Management, University of Warwick. This paper has been presented at workshops at the London Business School, the London School of Economics, the University of North Carolina at Chapel Hill, and the University of Colorado at Boulder. We are grateful for participants' comments, especially those of Dick Brealey, Ian Cooper, Jeremy Edwards, Mark Flannery, Bob Harris, John Kay, Colin Mayer, Anthony Neuberger, Steve Schaefer, and Jim Uskert. In addition, valuable suggestions were made by Michael Brennan, Dan Galai, Eduardo Schwartz, Sheridan Titman, and Walter Torous. We wish to thank a major UK leasing company for providing the data described in the empirical section. We would also like to thank Alan Outten of Forward Trust for helpful discussions on this subject. Finally, we thank the referee for many helpful comments and suggestions on earlier drafts. This paper was also presented at the Nineteenth Conference of the Western Finance Association, Vancouver, B.C., Canada, June 20–23, 1984.


In this paper, we examine leasing as a tax-arbitrage instrument. Analysis of a sample of UK leases presented in this paper suggests that lessors earn large positive NPVs. Our theoretical model seeks to explain these positive NPVs in terms of a market price for a scarce resource that we identify as scarce taxable earnings. Using these prices, the model permits a lessor to determine whether the profitability of a proposed set of lease contracts can be improved by writing a different set of contracts that makes better use of the lessor's taxable earnings. There may be two reasons why an initial portfolio of contracts may be suboptimal. Either there may be clienteles or the leasing market may be inefficient. Subsequently, we discuss reasons why the leasing market may be characterized by clienteles, and, using two different samples of leases, we test whether the leasing market is segmented and efficient.