Why Are Firms Unlevered?

49 Pages Posted: 25 Mar 2008 Last revised: 4 Jan 2011

See all articles by Erik Devos

Erik Devos

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance

Upinder Dhillon

SUNY at Binghamton - School of Management

Murali Jagannathan

SUNY at Binghamton - School of Management

Srinivasan Krishnamurthy

North Carolina State University - Poole College of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 30, 2010

Abstract

In this paper, we examine the relative explanatory power of three motivations for firms to remain debt free - managerial entrenchment, need for financial flexibility, and credit constraints. Consistent with the hypothesis that they lack access to debt markets, these firms are small, young, profitable, and lack a credit rating, and make fewer investments than their control firms. We reject the hypothesis that zero-leverage policies are driven by entrenched managers attempting to avoid the disciplinary pressures of debt. These firms do not have weaker internal or external governance mechanisms. The debt initiation decisions of these firms are not preceded by shocks to their entrenchment, such as takeover threats or the emergence of activist blockholders. These firms are able to access debt financing when profitable investments arise, allowing them to credibly certify the use of funds to lenders, who are mainly banks or other private lenders. A majority of the firms explicitly state in their 10-Ks that they raise debt to finance investments, indicating a causal link between debt initiation and investments.

Suggested Citation

Devos, Erik and Dhillon, Upinder S. and Jagannathan, Murali and Krishnamurthy, Srinivasan, Why Are Firms Unlevered? (December 30, 2010). Available at SSRN: https://ssrn.com/abstract=1107839 or http://dx.doi.org/10.2139/ssrn.1107839

Erik Devos

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance ( email )

500 W. University Ave.
El Paso, TX 79968
United States
915 747 7770 (Phone)

HOME PAGE: http://utminers/utep.edu/hdevos

Upinder S. Dhillon

SUNY at Binghamton - School of Management ( email )

Binghamton, NY 13902-6015
United States
607-777-4381 (Phone)
607-777-4422 (Fax)

Murali Jagannathan

SUNY at Binghamton - School of Management ( email )

P.O. Box 6015
Binghamton, NY 13902-6015
United States
607-777-4639 (Phone)

Srinivasan Krishnamurthy (Contact Author)

North Carolina State University - Poole College of Management ( email )

Hillsborough Street
Raleigh, NC 27695-8614
United States

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