DP12633 | Adverse Selection and Moral Hazard in the Leasing Market: Are Buybacks the Solution?

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We study the problem faced by a car-leasing firm in the presence of both adverse selection and moral hazard. While the literature has primarily focused on the role of leasing in avoiding adverse selection and the role of an above market buyback price in this environment, we show how this result reverses when moral hazard concerns are severe. The key driver of this result is that a low buy back price can incentivize non-contractible investment. We test the model using a difference-in-differences technique to compare accident outcomes of individuals driving leased company vehicles in Israel before and after a tax change and differentiate between drivers by their probability of utilizing the buyback clause. Our analysis shows that once exiting the leasing cycle becomes a relevant option due to a 110 percent increase in the tax rate on company cars it decreases the at-fault accident rate by half an accident per year (s.e. 0.25) for relevant drivers.