Capital structure and the substitutability versus complementarity nature of leases and debt

The capital structure irrelevance argument of Modigliani and Miller (1958) implies that the use of debt or leases should have no impact on firm values. This classical argument leaves out several important considerations crucial for the result, in particular, counterparty credit risk. We re-examine the capital structure problem for firms that can utilize debt and leases in the presence of counterparty risk. Our numerical and empirical estimates show a negative term structure of lease rates that steepens as a function of counterparty risk. Moreover, we document numerical evidence for the complementary relationship between debt and leases in the presence of counterparty risk.