Finite-horizon zero-leverage firms

Clark Lundberg and Babak Lotfaliei

Applied Economics Letters, 2020, vol. 27, issue 14, 1160-1169

Abstract: We develop a binomial lattice model of zero-leverage behaviour using a real option on debt issuance. With the option, firms may delay issuance even when debt is feasible and adds value to the firm. We find that firms are more likely to delay debt issuance when facing shorter debt horizons and longer option horizons. Our results suggest that firms earlier in their life cycle are more likely to be debt-free. This finding is consistent with empirical evidence that young firms are more likely to forgo debt. Our results also suggest that firms unable to access long-term debt markets are more inclined to be free of debt, even if short-term debt issuance is feasible.

Date: 2020
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DOI: 10.1080/13504851.2019.1675860

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