This paper aims to explore whether following an apparently sub-optimal “almost zero leverage (AZL)” policy by some Indian firms actually creates incremental value for their shareholders or is detrimental for them.
The paper investigates the relative equity market and operating performance of a sample of Indian firms adopting an AZL policy between 1998 and 2014, vis-a-vis, their leveraged peers from the same industry. The authors also look at the dynamic time variability of patterns, if any, in such relative performance and explore whether such patterns are explained primarily by investor perceptions or there are other factors to it.
The study show that Indian firms following post AZL policy exhibit superior equity performance compared to their leveraged counterparts, particularly during market downturns. The authors also find that this superior equity market performance is not merely because of the positive investor perception about the potential benefits of a robust debt-free balance sheet. The authors’ results show that the AZL firms register higher business risk and significantly superior operating performance, post being low leverage. The results hold even after using several robustness checks.
The study concludes that the managers of AZL firms take full advantage of the increased financial flexibility available with them and venture into riskier but more rewarding avenues and actually create incremental value for their shareholders.
The study highlights an apparently counterintuitive pattern in Indian context, counterintuitive particularly because choosing an AZL policy leads to forgo the availability of significant tax shield for firms. The results, the authors believe, can have significant implications for lenders and investors in the Indian capital markets in particular and emerging markets in general.
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