Why are Firms Unlevered?

Posted: 13 Feb 2012

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: February 10, 2012

Abstract

In this paper, we examine why firms have no debt in their capital structure. 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. Our evidence supports the hypothesis that these firms are financially constrained. Zero-debt firms are small, young, conserve cash from cash-flow, and are more likely to lease their assets. When they have access to a line of credit, they face stricter covenants and higher all-in costs than comparable control firms. They lose market share in economic downturns, consistent with the financial constraints explanation, but inconsistent with theories of predation which suggest that they may be voluntarily stockpiling debt capacity.

Keywords: leverage, managerial entrenchment, financing constraints

JEL Classification: D92, G32

Suggested Citation

Devos, Erik and Dhillon, Upinder S. and Jagannathan, Murali and Krishnamurthy, Srinivasan, Why are Firms Unlevered? (February 10, 2012). Journal of Corporate Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2002962

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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