Journal of Real Estate Finance and Economics, 27:1, 25±37, 2003
# 2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Effect of Firm Characteristics on the Use of
Percentage Retail Leases
GREGORY H. CHUN
Kimpo College, Kyoung-do, Korea, 415-870
MARK J. EPPLI
Marquette University, College of Business Administration, P.O. Box 1811, Milwaukee, Wisconsin
JAMES D. SHILLING
University of Wisconsin, School of Business, 975 University Avenue, Madison, Wisconsin 53706
Choice of lease payments has been widely studied in the literature. There are threeÐnot necessarily exclusiveÐ
explanations that have received attention. The ®rst attributes the choice of ®xed versus percentage lease payments
to risk-sharing preferences. The second explanation views percentage-of-sales lease agreements as a way
discriminating monopolists can appropriate economic rents. The third attributes percentage-of-sales lease
agreements to a metering and bonding argument. This paper examines the proposition that the choice of
percentage retail leases is driven in part by managements' desire to circumvent the cost of violating debt covenant
restrictions. The evidence presented here supports the prediction that retail ®rms with higher debt±asset ratios are
more likely to adopt percentage lease agreements.
Key Words: accounting, leases, ®nancial ratios
Research on risk-preferences proposes that the popularity of a percentage lease agreement
is linked directly to risk-sharing preferences.
The literature predicts this by making two
assumptionsÐthat some lessees are risk averse and some lessees are risk neutral. The
literature would then say that risk averse lessees will generally prefer percentage lease
agreements, while risk neutral lessees will generally prefer ®xed lease agreements. The
former occurs because the risk averse lessee prefers a certain income (after lease payment)
to a risky income, and the latter occurs because the risk neutral lessee is indifferent to a
certain income and an uncertain income and, hence, is willing to absorb the entire risk or
uncertainty with respect to retail sales demand (see Stiglitz, 1974). Both cases assume a
risk averse lessor.
There are two dif®culties with this view. First, risk-sharing models cannot explain why
it is only retail tenants and retail space where percentage-of-sales lease agreements exist.