An Examination of Leasing Policy, Tax Rates, and Financial Stability in the Restaurant Industry

Abstract

Prior research has examined the relationship between debt financing and marginal tax rates to help explain the capital structure choice of firms. However, this type of measure is subject to an endogeneity problem, whereby an examination of postfinancing tax rates and debt financing produces a spurious negative relationship. Therefore, a before-financing tax rate may be a more accurate indicator of the use of debt financing versus leasing. This article uses both tax rate estimates to examine the relationship between tax rates and leasing behavior for a sample of restaurant firms. The authors also document a negative relation between the use of operating leases and the marginal tax rate faced by the firm and compare the accuracy of the two tax rate measures in predicting leasing and debt policy. Finally, the authors examine the relationship between leasing behavior and a firm’s financial stability.