Does the eye of the master make the horse fat? Maintenance of collateral and asset care under purchase and leasing contracts

The paper presents a theory of leasing in which asset use and maintenance shape the …firm’s decision between purchasing or leasing productive assets. When the maintenance of the asset cannot be carefully specifi…ed as part of the loan agreement, its level may be suboptimal, and jeopardise the return to the …nanciers in case of default, thus eroding the bene…t of collateral pledging, particularly relevant for fi…nancially constrained …firms. Operating leasing allows to overcome such shortcoming, as the maintenance is delegated to the lessor. However, this delegation generates a novel moral hazard problem on the lessee, who, by not paying for maintenance, does not internalise the use incentive and may practice inefficiently low levels of care and cause asset depletion. The paper characterises circumstances in which it may be optimal to lease rather than buy and rationalises some observed features of leasing contracts.