Zero-debt policy under asymmetric information, flexibility and free cash flow considerations

Miglo, Anton ORCID: https://orcid.org/0000-0002-9237-5293 (2020) Zero-debt policy under asymmetric information, flexibility and free cash flow considerations. Journal of Risk and Financial Management, 13 (12). ISSN 1911-8066

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Abstract

We build a model of debt for firms with investment projects, for which flexibility and free cash flow problems are important issues. We focus on the factors that lead the firm to select the zero-debt policy. Our model provides an explanation of the so-called “zero-leverage puzzle”. It also helps to explain why zero-debt firms often pay higher dividends when compared to other firms. In addition, the model generates new empirical predictions that have not yet been tested. For example, it predicts that firms with zero-debt policy should be influenced by free cash flow considerations more than by bankruptcy cost considerations. Additionally, the choice of zero-debt policy can be used by high-quality firms to signal their quality. This is in contrast to most traditional signalling literature where debt serves as a signal of quality. The model can explain why the probability of selecting the zero-debt policy is positively correlated with profitability and investment size and negatively correlated with the tax rate. It also predicts that firms that are farther away from their target capital structures are less likely to select the zero-debt policy when compared to firms that are close to their target levels

Item Type: Article
Uncontrolled Keywords: zero-debt policy,flexibility,capital structure,tax shield,free cash flow problem,dividend policy,debt overhang
Faculty \ School: Faculty of Social Sciences > School of Economics
Related URLs:
Depositing User: LivePure Connector
Date Deposited: 28 Oct 2021 00:49
Last Modified: 10 Oct 2022 15:31
URI: https://ueaeprints.uea.ac.uk/id/eprint/81904
DOI: 10.3390/jrfm13120296

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