An empirical analysis of zero-leverage and ultra-low leverage firms: some UK evidence

An empirical analysis of zero-leverage and ultra-low leverage firms: some UK evidence
Document type
Working Paper
Author(s)
Dang, Viet Anh
Publisher
Manchester Business School
Date of publication
1 October 2009
Series
University of Manchester Business School Working Papers
Subject(s)
Management & leadership: including strategy, public sector management, operations and production, Trends: economic, social and technology trends affecting business
Collection
Business and management
Material type
Reports

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This paper studies conservative debt policies, focusing on firms with no debt (zeroleverage) or with extremely low debt. Examining an unbalanced panel of UK firms, the paper shows that debt conservatism is a common, persistent yet puzzling empirical regularity: nearly 10% of UK firms have zero leverage and 18% have market leverage of less than or equal to 1% (ultra-low leverage). Firms maintaining zeroleverage or ultra-low leverage are generally smaller, younger, and less profitable but have a higher payout ratio. These firms also have substantial cash reserves and rely heavily on equity financing in order to mitigate underinvestment incentives. Firms with high-growth opportunities are more likely to adopt and switch to an extremely conservative debt policy. Firms with a large deviation from the target leverage are more likely to lever up. Our explanations for the zero-leverage puzzle are inconsistent with the pecking order theory, inconclusive on the financial flexibility hypothesis but generally supportive of the underinvestment hypothesis and the dynamic trade-off theory.

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