| Various elements in firms' capital structures have been documented to be associated with conflicts of interests among shareholders, creditors, and managers. In this paper, I hypothesize that the use of leases affects manager incentives and mitigates the conflicts of interests between shareholders and bondholders. I test this hypothesis by examining whether leasing shares in the capital structure are associated with CEO pay-performance sensitivity. My results show that a firm's leasing share is positively associated with its CEO's pay-performance sensitivity, suggesting that leasing activities reduce the agency cost of debt financing. My results remain robust after controlling for recognized mechanisms of reducing agency cost of debt such as convertible debt and short-term debt, and also suggest that operating leases and capital leases act differently in mitigating agency problems. In the end, I show that the use of leases differs in high-growth and low-growth firms. This paper contributes to the literature by empirically identifying a mechanism that reduces the agency cost of debt financing. |
