SSRN-Moral Hazard in Leasing Contracts: Evidence from the New York City Taxi Industry by Henry Schneider

Great for class! Interesting, memorable, and on a topic which students often find boring and forgetful.

Leasing is an important, but understudied method of financing a wide range of assets. Unlike owning an asset where the owner of the asset is also the user of the asset, in a lease (and also in a rental agreement), the asset is used by one party (lessee) and only reverts to the lessor after the contract expires. Thus, it can lead to behaviors that are different than if the owner was also using the asset.

These differing behaviors are generally called a moral hazard problem and can help explain why many treat a rental car differently than their own vehicle.

Henry Schneider takes this idea one step (uh, one mile may be more appropriate) and examines the differences between taxi cab driver behavior when the taxi is leased vs when it is not.

the main finding: Even after controlling for endogeniety problems (that is self selection where safer drivers might be more apt to own), leasing does seem to lessen the maintenance and care of the vehicles and lead to more accidents.

The paper: SSRN-Moral Hazard in Leasing Contracts: Evidence from the New York City Taxi Industry by Henry Schneider:

"...evidence about the leasing moral hazard by examining the New York City taxi industry, which is split between taxis operated exclusively by lessees and taxis with owner-drivers. Lessees have significantly worse driving outcomes than owner drivers:

In 2005, long-term lessees experienced 62 per cent more accidents and 64 percent
more driving violations per mile than owner-drivers, and operated taxis that failed vehicle
emissions and safety inspections at a 67 percent higher rate. Moral hazard is an obvious candidate to explain these differences...contracting over driving outcomes instead of actions also faces obstacles since taxis are typically operated by multiple drivers, which prevents some driving outcomes (e.g., vehicle mechanical failures) from being matched to individual drivers....",

On the endogeneity issue:

"...controlling for driver and vehicle characteristics is not straightforward: As
with most empirical work in contract theory...address this challenge in three ways. First, I
estimate the difference in outcomes between lessees and owner-drivers conditioning on a
rich set of observed driver characteristics. Second, I conduct an instrumental variables
analysis to address the possibility of unobserved driving risk that is correlated with leasing
choice, instrumenting for leasing choice with community norms for taxi-ownership. Third,
I compare the before and after outcomes of the 1,130 drivers who switched from leasing
to owning during the sample period....All of these approaches yield qualitatively similar results..."

and finally:

"After controlling for vehicle usage and driver characteristics, I estimate that moral
hazard explains 34 percent of lessees’ violations, 18 percent of their accidents, and 30
percent of leased taxis’ vehicle inspection failures."

Cite: Schneider, Henry S.,Moral Hazard in Leasing Contracts: Evidence from the New York City Taxi Industry(November 2008). Johnson School Research Paper Series No. #03-09. Available at SSRN: http://ssrn.com/abstract=1146648

good stuff!!