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

Miglo A. Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow Considerations. Journal of Risk and Financial Management. 2020; 13(12):296

25 Pages Posted: 19 Jan 2021

See all articles by Anton Miglo

Anton Miglo

University of Salford; Birmingham City University

Multiple version iconThere are 2 versions of this paper

Date Written: 2020

Abstract

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

Suggested Citation

Miglo, Anton, Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow Considerations (2020). Miglo A. Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow Considerations. Journal of Risk and Financial Management. 2020; 13(12):296, Available at SSRN: https://ssrn.com/abstract=3766811

Anton Miglo (Contact Author)

University of Salford ( email )

Salford, Greater Manchester M5 4WT
United Kingdom

Birmingham City University ( email )

School of Social Sciences
City North Campus
Birmingham, West Midlands B42 2SU
United Kingdom

HOME PAGE: http://https://www.bcu.ac.uk/business-school/about-us/our-staff/anton-miglo

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