The Economic, Financial Accounting and Governance Determinants of Synthetic Lease Financing

The synthetic lease is a hybrid financing structure that allows a company to have many of the benefits of asset ownership, including capital lease treatment for tax purposes, while treating lease payments as operating expenses on the firms income statement. Proponents of these transactions argue that the complexity of these structures is necessary to provide economic benefits to the firm and its shareholders. Critics argue that these transactions are severely lacking in transparency, and the benefits that derive from these transactions are the result of short-sighted opportunistic behavior by managers that lead to wealth extraction from other groups of stakeholders. I jointly examine (1) whether the structure of the synthetic lease does, as supporters argue, provide favorable financing terms for firms that choose this type of transaction, (2) the economic and financial accounting incentives that influence the managers financing choice and (3) the role of the board of directors in the decision making process. I find evidence that supports both economic benefits associated with the lease, as well as managers using synthetic lease financing for opportunistic gains. The results also show that, all else equal, the probability of choosing synthetic lease financing is increasing in the strength of a firms board of directors, consistent with strong boards being able to understand the complexity of the transaction and the associated benefits. However, I also find that if managers have incentives to use the synthetic lease to engage in opportunistic behavior, the presence of strong monitors prevents managers use of synthetic leases for this purpose.