Zero Leverage Firms

Najam Us Sahar
Leverage:

In finance, leverage (sometimes referred to as gearing in the United Kingdom

and Australia) is any technique involving the use of borrowed funds in the
purchase of an asset, with the expectation that the after tax income from the
asset and asset price appreciation will exceed the borrowing cost.
Limits
Risks and Returns: Bankruptcy, loss in value of asset, illiquidity,
Investment: Accounting leverage, economic leverage
Corporate Finance: Operating leverage, Financing leverage and combined
leverage
Financial Leverage and Crises
Zero Leverage

Zero Leverage (ZL) Firm: A firm is a ZL firm if in year t the outstanding

amount of both short term and long term debt equal zero.
Almost Zero Leverage (AZL) Firm: Is a firm which has quasi market leverage
or book leverage ratio less that 5%. ( although choice of 5% is adhoc, it
represents a firm which is debt averse)
 S&P 500 index: such as Apple, Yahoo, Texas Instruments, Bed Bath & Beyond
or Urban Outfitters, are examples for the stylized fact in corporate finance
that the proportion of zero-leverage firms has sharply increased over time
10.2% of large public nonfinancial US firms have zero debt and almost 22%
have less than 5% book leverage ratio.
Countries with a common law system, high creditor protection, and a
dividend imputation or dividend relief tax system exhibit the highest
percentage of zero-leverage firms.
 ZL/AZL firms pay higher dividends and have higher cash balances
Theoretically, zero leverage dividend paying firms are effectively replacing
payout to debt holders with that to equity
holders.
zero leverage have a lower cost of equity capital in countries where a zero-
leverage policy is more compatible with the local culture.
Firms with higher Chief Executive Officer (CEO) ownership and longer CEO
tenure are more likely to have zero debt, especially if boards are smaller and
less independent. Family firms are also more likely to be zero-levered
The longrun equity performance of
zeroleverage firms

zerodebt firms perform better over the long run based on the calendartime
portfolio regressions after adjusting for FamaFrench factors.
the impact of extreme conservatism in debt policy is not fully captured by the
theoretical and empirical risk proxies, such as beta, size, booktomarket,
and momentum.
Dividend-paying zero-leverage firms pay substantially higher dividends, are
more profitable, pay higher taxes, issue less equity, and
have higher cash balances than control firms chosen by industry and size.
Firms with higher Chief Executive Officer (CEO) ownership and longer CEO
tenure are more likely to have zero debt, especially if boards are smaller and
less independent. Family firms are also more likely to be zero-levered
Understanding Zero Leverage Behavior:

There are two distinct groups of unlevered firms with different levels of
constraints as measured by their dividend policy, namely payers and non-
payers
Firms in the second group (non-payers) have zero leverage mainly due to
financial constraints
first group (payers) deliberately eschew debt to mitigate investment
distortions, as predicted by the underinvestment and financial flexibility
hypotheses
Theory Impact :

violate trade off propositions and support Grahams (2000) assertion that
large, profitable, liquid, in stable industries, and face low ex ante costs of
distress" (p. 1902) are under levered.