1959-Illusion in Lease Financing

•Stockholdersmaynotbeawareoftheextenttowhichrentedcapitalisusedinthecompany;andmanagementmaynotrealizethesignificanceofthelong-termeommit-mentsinvolved;butthereisboundtobeadayofwakening.fLLUSIOJVinLeaseFinancingDonaldR.Gant•Isleasefinaneinganewapproachormerelyanotberformofborrowing?•Aretheadvantageswbiehleasefinaneingap-pearstoofferoverownersbiprealorillusory?•Canleasefinancingreallymakeitpossibleforacompanytohaveitseakeandeatit,too?SignsreadingBuyorLeaseareafamiliarsightonvacantlotsandbuildings.Butinre-centyearstbechoiceexpressedinthesethree^vordshasbecomemorethanjustthelureusedbyreal-estateagentstoattractprospectiveclients.Ithasbecomeanissueofgreatimportancetothetopmanagementofeompaniesinalmosteveryindustry,\vithimplicationsreachingtotbehighestlevelsofcorporateFmancialpolicy.Andasthecontroversyovertherelativemeritsofthealternativeshasmonnted,billionsofdollarsbaveheenwageredonbothsides.RentedCapitalInthepatternofexternalfinaneingresultingfromtheunprecedenteddemandsforcapitalim-posedbypostwargrowthandexpansion,atleasttwosignificantdevelopmentsdeserveattention.Onebasbeenwidelyrecognized:thedecidedtendencytowardborrowedeapitalinpreferencetoequitycapital.FigurescompiledbytheSe-curitiesantiExchangeCommissionindicatethatoftbe$33billionraisedhyindustrialcorpo-rationsduringtheten-yearperiodfrom1948through1957,moretbanthreequartersofittooktheformofdebtfinancing.Tbisisex-elusiveofloans,botbsbort-termandlong-term,madebycommercialbanks.Theotherdevelopment,whiehhasattractedfarlessattention,basbeentheemergeneedur-ingtbisperiodofanotlierformofeapitalasamajorsourceofcorporatefunds.Thismightbetermedrentedcapital—assetsfinancedbymeansofleases,Altboughtherearenofig-uresbywhichtogaugetheimportanceofrentedcapitalincomparison\^iththemoretradition-alforms,leasefinancingisunquestionablytbeprineipalmethodofexternalfinaneingbeingemployedinsomeindustries.Moreover,itsuseisrapidlybeingextendedbotbtonewindus-triesandtonewapplications.Whileleasinghasfounditsprincipalapplicationtodateintbefinancingofrealestate,itisnowpossibletoleasealmostanytypeofcapitalassetabusi-nessmayrequire,fromofficeequipmenttoindus-trialmacbincry,ships,andairplanes.Anexampleoftheun;queadaptabilityoftheleasetovariousfinancingproblemsisprovidedbytheairlinesindustry:Theadventoftheeommereialjetairlinerbaseonfrontedtbeairlineswitbagreatmanyproblems,butnonemoreimposingtbantbequestionofbowtheyaretoraisetbetremendousamountsofaddi-tionaleapitalre(|uiredtofinaneetbeebangeoverfrompiston-typeaircraft.NowAmerieanAirlinesappearstobavefoundatleastapartialsolutiontotbisprobleminanarrangementtoleasetbejetenginesformostofitsnewplanes.Amerieanhasannouncedthattbiswillreducetbeeapitalre-quirementforitsjetprogrambyabout$80million.121122HarvardBusinessReviewThegrowthofleasefinancinghaswonitanenthusiasticbandofsupporters.Theyhavepointedoutthemanyadvantageswhichitof-fers—advantageswhichmakethealternativeot'ownershipappearoutmoded.Perhapstheprincipalargumentraisedinitsbehalfisthatitpermitsacompanytopurchasetheuseofanassetasitisneeded,inthesamewaythatelec-tricpowerandtelephoneservicearepurchased,andthusavoidsthecapitalinvestmentandre-sponsibilitieswhichownershipentails.Unboundedenthusiasmforleasefinancingisnotsharedinallquarters,however.Toanim-portantsegmentofthefinancialcommunity,leasefinancing,strippedofitsillusions,isnotafreshnewapproachtotheacquisitionoffixedassetsatall,butmerelyanoldfriendindis-guise.Itisseenasbasicallyanotherformofdebtfinancing,anextensionoftheprefereneeforborrowedcapitalnotedearlier.Andfromthisviewpointtherearedangersinthegrowingtrendtowartileasefinancingtotheextentthatcompaniesusingit,andinvestorsintheirsecuri-ties,failtoappreciatetheimplicationsoftheirmountingleasecommitmentsmerelybecausetheyareburiedinafootnoteratherthanappear-ingasliabilitiesonthebalancesheet.FinancialPolicyWhateonstitutesleasefinancing?Everycompanypaysrentinsomeformorothertoob-taintheservieesofagreatvarietyofassets.Certainlynotallthesearrangementseouldbeconsideredtorepresentfinancing.Fromanop-cratingstandpoint,leasingmayoftenbetheonlypracticalwaytoobtaintheuseofanasset.Leasefinancingisaspecializedformofleas-ing.Inabroadsense,thetermimpliesthatleasinghasbeenremovedfromtheoperat-inglevelandmadeamatteroffinancialpolicy,throughtheadoptionoftheleaseasasubstituteforothermethodsoffinancing.Asusedinthisarticle,then,leasefinancingreferstoarrange-mentswhichhavethesebasiccharacteristics:•Aleasewhichisdesignedtogivethecom-panytherighttotheuseofanassetduringall,oratleastthemajorpartof,theasset'seconomiclife.•Apracticablealternativeofownershipoftheassetbythecompany,withthedecisionbetweenowningandleasingturningonfinancialratherthanoperatingconsiderations.Therearemanyleasingarrangementswhichwouldnotfallwithinthiscategory,somebe-causetheneedfortheassetistooshortindura-tiontojustifyowningit(suchasarequirementfortemporarywarehousespaceorforadditionaloiltankerstomeetanunusualdemandofthetypecreatedbytheSuezcrisis),othersbecauseownershipisnotpracticable(e.g.,rentingofficespaceinmetropolitanareaswheretheowner-shipofan