Managing the Balance Sheet with Leases

We document significantly increased reliance on off-balance-sheet (OBS) lease financing that is inconsistent with economic theory. Specifically, the increase is greatest among non-distressed firms characterized by growth options and high R&D but without obvious tax incentives. We explore alternative incentives and find that (1) OBS leasing enables firms to manage debt covenants limiting debt or capital expenditures, (2) excess OBS leasing is diminished by scrutiny of institutional investors, and (3) firms investigated by the SEC or DOJ for financial misrepresentation exhibit high levels of excess OBS leasing. Overall, we conclude that firms use OBS leases to expand their debt capacity while preserving conservative balance sheets.