Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow Considerations

31 Pages Posted: 27 Mar 2019

Multiple version iconThere are 2 versions of this paper

Date Written: March 21, 2019


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" (Strebulaev and Yang (2013)). It also helps to explain why zero-debt firms often pay higher dividends 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. Also 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 such as Leland and Pyle (1977), for example, 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 compared to firms that are close to their target levels.

Keywords: Zero-Debt Policy; Flexibility; Capital Structure; Tax Shield; Free Cash Flow Problem; Debt Overhang; Dividend Policy

JEL Classification: D82, G32, L11, L26, M13

Suggested Citation

Miglo, Anton, Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow Considerations (March 21, 2019). Available at SSRN: or

Anton Miglo (Contact Author)

University of East Anglia ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

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