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Is the zero-leverage policy value-enhancing?

Author

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  • Jiang, Wenwen
  • Kang, Jangkoo
  • Kim, Hwa-Sung

Abstract

Incompatible with standard capital structure theories, zero-leverage (ZL) firms are becoming increasingly common in recent decades. In this study, we examine whether shareholders consider a firm’s ZL policy value-enhancing or value-reducing. Using Faulkender and Wang’s (2006) methodology, we find that shareholders place a positive value on the event of a firm switching to zero debt. Furthermore, this valuation is not affected by whether the firm faces a managerial entrenchment problem, but is affected significantly by whether it is financially constrained before becoming debt-free. We find that shareholders place no value on a financially constrained firm following a ZL policy, but place a positive value on an unconstrained firm doing so, indicating that they only consider the latter as a value-enhancing policy. We also show that our finding still holds even when conducting an event study with short-term event windows. We infer that shareholders’ positive valuation on financially unconstrained firms is related to the financial flexibility of ZL policies.

Suggested Citation

  • Jiang, Wenwen & Kang, Jangkoo & Kim, Hwa-Sung, 2024. "Is the zero-leverage policy value-enhancing?," The Quarterly Review of Economics and Finance, Elsevier, vol. 93(C), pages 176-189.
  • Handle: RePEc:eee:quaeco:v:93:y:2024:i:c:p:176-189
    DOI: 10.1016/j.qref.2023.12.007
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    More about this item

    Keywords

    Zero-leverage; Financial flexibility; Financial constraint; Managerial entrenchment;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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