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The effect of debt capacity on the long-term stock returns of debt-free firms

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  • Gisung Moon
  • Hongbok Lee
  • Doug Waggle

Abstract

This article examines the long-term stock market performance of debt-free firms with high and low levels of debt capacity to see whether they are different. We use Fama and French's (1993) three-factor and Carhart's (1997) four-factor models to examine the subsequent 1, 2, 3, 4 and 5-year stock returns of firms that stayed debt free for 3- and 5-year periods. We measure debt capacity as the expected asset liquidation value of a firm, which is proxied by the firm-level tangibility measure defined by Berger, Ofek, and Swary (1996). We find that regardless of the level of debt capacity, zero-debt firms generate positive abnormal returns in the long run after controlling for key risk factors. We also find support for the notion that preserving debt capacity in the form of higher tangibility reinforces the positive abnormal returns over and above the effect of a zero-leverage policy.

Suggested Citation

  • Gisung Moon & Hongbok Lee & Doug Waggle, 2015. "The effect of debt capacity on the long-term stock returns of debt-free firms," Applied Economics, Taylor & Francis Journals, vol. 47(4), pages 333-345, January.
    • Handle: RePEc:taf:applec:v:47:y:2015:i:4:p:333-345
    DOI: 10.1080/00036846.2014.959655
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    Cited by:

    1. Hossain, Mohammed Sawkat, 2021. "A revisit of capital structure puzzle: Global evidence and analysis," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 657-678.

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