 Zero-Debt Policy under Asymmetric Information, Flexibility and Free Cash Flow ConsiderationsJRFM, 2020, vol. 13, issue 12, 1-25 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”. It also helps to explain why zero-debt firms often pay higher dividends when 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. Additionally, 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 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 when 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 (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:gam:jjrfmx:v:13:y:2020:i:12:p:296-:d:452761 Access Statistics for this article JRFM is currently edited by Ms. Chelthy Cheng More articles in JRFM from MDPI |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.