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