Do Stocks of Debt-Free Firms Perform Better in the Long Run?

What is it about?

Some companies choose to operate without debt for extended periods even though borrowing can provide important benefits. This study examines the long-term stock performance of firms that maintained zero debt for three or five consecutive years. We evaluate their subsequent stock returns using several approaches that account for differences in risk and firm characteristics. We find that debt-free firms generally exhibit positive long-run abnormal stock performance, particularly when returns are evaluated using calendar-time portfolio methods.

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Why is it important?

Traditional finance theory suggests that borrowing can benefit companies, particularly through tax advantages, yet some firms consistently choose to operate without debt. Understanding the performance of these firms can provide insights into why companies may adopt extremely conservative debt policies. Our findings show that debt-free firms exhibit positive long-run abnormal stock performance after controlling for common risk factors. These results suggest that maintaining a zero-debt policy does not necessarily put firms at a disadvantage and provide useful evidence for understanding the relationship between capital structure decisions and long-term stock performance.

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