Leasing and the allocation efficiency of finance

This paper argues that leasing, as an important but often ignored source of external financing, facilitates the allocation efficiency of finance. We document a large overestimation of measured finance misallocation (Whited and Zhao, 2021) when lease-induced debt is ignored among US manufacturing firms. The losses in real value-added due to finance misallocation drop from 25% to 19% after appropriately adjusting for lease. This amounts to a 6-percentage-point reduction in measured misallocation inefficiency. In the time-series, this inefficiency reduction from lease-adjustment exhibits a strong countercyclical pattern. In the cross-section, we find such reduction presents asymmetric patterns for firms with different size — it is more salient within small firms than in large firms. Leasing improves the allocation of finance by raising the total amount of finance as well as by alleviating inefficient debt-equity combinations across firms. Finally, we find that factoring in lease-induced debt lowers both the level and dispersion of finance costs, consistent with the mitigation effect of lease-adjustment on finance allocation efficiency.