The Mystery of Zero-Leverage Firms

Abstract:     
This paper documents the puzzling evidence that a substantial number of large public non-financial US firms follow a zero-debt policy. Over the 1962-2003 period, on average 9% of such firms have zero leverage and almost 23% have less than 5% quasi-market leverage ratio. Zero-leverage behavior is a persistent phenomenon. More than a quarter of zero-leverage firms refrain from debt for at least five consecutive years. We find that while zero-leverage firms are smaller than other firms in their industries, neither industry nor size explains their puzzling behavior. Particularly surprising is the presence of a large number of zero-leverage firms who pay dividends. Dividend-paying zero-leverage firms are more profitable, pay higher taxes and have higher cash balances than their proxies chosen by industry and size. These firms also pay substantially higher dividends than their proxies and thus the total payout ratio is relatively independent of leverage. We also find that age of the firm is unlikely to explain extreme debt-aversion behavior. We propose a number of economic explanations aiming to explain the empirical evidence and, by testing some of them, fail so far to provide any reasonable explanation of the puzzle.

Keywords: Leverage, debt financing, capital structure, zero leverage, financing

JEL Classifications: G12, G32, G33

Working Paper Series