The International Zero-Leverage Phenomenon

Abstract

Zero-leverage is an international phenomenon which has increased over time. The increasing prevalence of zero-leverage firms is related to IPO waves and the accompanying changes in industry composition. In addition, we attribute the higher propensity to maintain a zero-leverage policy throughout all size and age groups to increasing asset volatility and decreasing corporate tax rates during our sample period. Countries with a common law system, high creditor protection, and a dividend imputation or dividend relief tax system exhibit the highest percentage of zero-leverage firms. Analyzing supply-side capital market frictions, we find that only a small number of profitable firms with high payout ratios deliberately maintain zero-leverage. In contrast, most zero-leverage firms are con-strained by their debt capacity; they are smaller, riskier, and less profitable, and they are the most active equity issuers. With respect to the demand-side of financing choices, we show that firms which pursue a zero-leverage policy only for a short period of time seek financial flexibility. After abandoning zero-leverage, these mostly un-constrained firms switch to higher leverage ratios, make higher investments, and reduce their cash holdings by a larger amount compared to constrained zero-leverage firms, which remain debt-free for longer periods of time.

Keywords: Capital structure, zero-leverage, debt conservatism, financial constraints, financial flexibility

JEL Classification: G32