Information Costs, Transactions Costs, and Leasing: Theory and Evidence from the Automobile Industry

Justin Johnson, Cornell University
Henry S. Schneider, Cornell University
Michael Waldman, Cornell University

Abstract

Building on recent theoretical research, we construct a model of the leasing decision that incorporates adverse selection, moral hazard, and transaction costs. In our model leasing mitigates adverse selection and reduces transaction costs, but moral hazard is an important cost of leasing that limits its use. We use this model to derive a number of testable implications and then conduct an empirical analysis of the new-car and used-car markets to investigate whether the operation of these markets is consistent with predictions of this theoretical approach. Overall, we find that the operation of these markets is indeed consistent with testable predictions from this approach. The paper also considers alternative theories of leasing and argues that the data is better explained by the adverse-selection/moral-hazard/transaction-cost theory of leasing than any of the existing alternatives.