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

Miglo, A. (2020) Zero-debt policy under asymmetric information, flexibility and free cash flow considerations. Journal of Risk and Financial Management, 13(12), 296. (doi: 10.3390/jrfm13120296)

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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:Articles
Glasgow Author(s) Enlighten ID:Miglo, Dr Anton
Authors: Miglo, A.
College/School:College of Social Sciences > Adam Smith Business School > Accounting and Finance
Journal Name:Journal of Risk and Financial Management
ISSN (Online):1911-8066
Published Online:28 November 2020
Copyright Holders:Copyright © 2020 The Author
First Published:First published in Journal of Risk and Financial Management 13(12): 296
Publisher Policy:Reproduced under a Creative Commons License

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