The motivational heterogeneity of an all-equity capital structure

Purpose - This paper aims to investigate whether all-equity firms are a heterogeneous group as it relates to agency costs when compared to a matched sample of levered firms and to contribute toward the understanding of the “low leverage” puzzle and the motivations behind such a perplexing phenomenon. Design/methodology/approach - Propensity score matching (PSM) is used to control for endogeneity issues common to this line of research. Because all-equity firms are self-selecting, it is not possible to conduct a true randomized study. PSM attempts to simulate a randomized study by selecting matching observations with similar propensity scores as the all-equity observations. Findings - Agency costs are not the only explanation leading to the implementation of an all-equity capital structure. The motivation of such structure is strongly influenced by free cash flows (FCF) and growth opportunities (GO), whereby firms that have high levels FCF combined with low GO exhibit higher levels of agency costs versus their levered peers, while those that have low levels of FCF and high GO exhibit no significant difference in agency costs. Practical implications - A better understanding of why a firm chooses such an extreme capital structure can help investors, auditors and potential future creditors in their decision-making process. Originality/value - Most prior research treats capital structure as an exogenous variable. By applying PSM, not previously used in prior research, a new methodology is used to address the endogeneity issue related to observational studies such as this one. This paper contributes toward further understanding the perplexing “low-leverage” puzzle often discussed in the financial and accounting literature.