Why Do Some Firms Go Debt Free?

Abstract

Abstract This paper examines debt‐free firms. We find that favorable equity market valuation and borrowing constraints contribute to these firms' extreme debt conservatism. Small debt‐free firms with little access to credit markets are seen to raise equity while paying high dividends. Large debt‐free firms, generating more cash flows relative to their investment needs, often pay off their debt while paying high dividends. The results suggest that high dividends for small debt‐free firms help them establish good reputations in equity markets, while high dividends for large debt‐free firms reduce the agency costs of free cash flow.