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Why are firms unlevered?

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  • Devos, Erik
  • Dhillon, Upinder
  • Jagannathan, Murali
  • Krishnamurthy, Srinivasan

Abstract

In this paper, we examine why firms have no debt in their capital structure. We reject the hypothesis that zero-leverage policies are driven by entrenched managers attempting to avoid the disciplinary pressures of debt. These firms do not have weaker internal or external governance mechanisms. The debt initiation decisions of these firms are not preceded by shocks to their entrenchment, such as takeover threats or the emergence of activist blockholders. Our evidence supports the hypothesis that these firms are financially constrained. Zero-debt firms are small, young, conserve cash from cash-flow, and are more likely to lease their assets. When they have access to a line of credit, they face stricter covenants and higher all-in costs than comparable control firms. They lose market share in economic downturns, consistent with the financial constraints explanation, but inconsistent with theories of predation which suggest that they may be voluntarily stockpiling debt capacity.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Corporate Finance.

Volume (Year): 18 (2012)
Issue (Month): 3 ()
Pages: 664-682

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Handle: RePEc:eee:corfin:v:18:y:2012:i:3:p:664-682

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Web page: http://www.elsevier.com/locate/jcorpfin

Related research

Keywords: Leverage; Managerial entrenchment; Financing constraints;

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References

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Cited by:
  1. Dang, Viet Anh, 2013. "An empirical analysis of zero-leverage firms: New evidence from the UK," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 189-202.
  2. Bessler, Wolfgang & Drobetz, Wolfgang & Haller, Rebekka & Meier, Iwan, 2013. "The international zero-leverage phenomenon," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 196-221.

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