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Keywords:

  • Capital structure;
  • Dividend policy;
  • Zero debt

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.