Performance of debt free firms

Abstract

This paper compares the performance of portfolios of debt free firms to comparable portfolios of leveraged firms. The results of the study indicate that investments in portfolios of debt free firms tend to generate higher returns than investments in their peer portfolios of leveraged firms over long and short periods. The results have clear implications for investment decisions and investment performance. Investors tend to reward firms that resist the urge to borrow heavily and operate with debt free balance sheets and penalize firms that have high levels of debt. Moreover, during market downturns, debt free firms will not have the additional burden of debt and may be able to recover much faster than companies that carry a debt load over a long period of time, and therefore would outperform leveraged firms. This latter assertion may be retested after the latest international financial crises come to an end.

The implications of financial performance on stock exchange indicators of listed companies: empirical evidence for the Romanian capital market

“…Financial leverage presents a significant negative effect (at the 1% level) on stock exchange performance, confirming expectations that increasing the indebtedness degree of the company would bring down its value in the view of investors. This result confirms the findings of previous studies (Korteweg, 2004, Zaher, 2010, which found that investments made in companies with low financial leverage give higher returns to investors.…”

Does it Pay to Invest in Debt Free Firms During Recessions?

“…The findings in this study support those of Dimitrov and Jain (2006), Korteweg (2004), Penman et al (2007). Zaher (2010), who provided evidence that that there is a negative relationship between leverage and stock returns, contradicts the study by Bhandari (1988), who argues that stock returns increase with leverage.…”

Research on Returns Generated by Debt (Levered) and Zero Debt (Unlevered) Firms

“…Bhandari (1988) [4] studied the effect of total common equity, beta and debt equity ratio on the average returns generated by the stocks. Zaher (2009) [10] has studied the performance of debt free firms specifically. This paper compares the equity performances of leveraged and zero debt firms.…”

“…But there is a negative side too to the debt story. It involves outflow of cash at regular intervals which may stifle the net flow of cash (Zaher 2009) [10]. Both, being a zero debt firm or a leveraged firm have their own sets of pros and cons.…”

“…Zaher (2009) [10] studied whether investors who preferred zero debt firms were rewarded more than those who invested in leveraged firms. The study found that portfolio comprising of debt free firms performed better than the portfolio comprising of leveraged firms.…”