Is debt conservatism the solution to financial constraints? An empirical analysis of Japanese firms

ABSTRACT

This paper investigates why firms choose the conservative financing strategy known as non-positive net debt policy, which is a more recent prevalent trend among Japanese firms. The analysis reveals that Japanese firms are more likely to be financially conservative if they are smaller, older and more profitable and have fewer growth opportunities and tangibility. The survival analysis further investigates the duration of conservative debt policy and ordinary debt policy. The evidence shows that firms adopt/abandon the conservative policy with different motivations and preferences over debt conservatism. In particular, we argue that the more financially constrained firms abandon the conservative debt policy sooner than their counterparts, while less financially constrained firms abandon the ordinary (less conservative) debt policy sooner than their counterparts. The results suggest that a firm uses a conservative debt policy in terms of net leverage as a temporary buffer to mitigate financial constraints.

KEYWORDS:

• Capital structure
• debt conservatism
• financial constraints
• zero leverage
• financial flexibility

JEL CLASSIFICATION:

• G32
• G31
• G35
• C41

Acknowledgments

For helpful comments and discussions, I thank the participants and discussants at the 41^st Japan Finance Association Annual Meeting.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Meanwhile, Bessler et al. (2013) also indicate that the unlevered firms are more prevalent in common law countries rather than in civil law countries since the capital market is the primary source of funds in common law countries while firms in civil law countries depend more on financial institutions..

² The data come from the Nikkei..

³ The exclusion of missing values on variables causes the sample period to shrink from 1997 to 2015, as the dividends and R&D data are not reported until 1997..

⁴ Table 1 only shows the complete NPND durations. The censored samples, which are those NPND events that begin before 1997 or end after 2015, are excluded..

⁵ See in Byoun and Xu (2013), Dang (2013), DeAngelo and DeAngolo (2007), Strebulaev and Yang (2013).

⁶ The payout is defined as the sum of dividend and share repurchases divided by total assets. The payout constrained and unconstrained firms are defined before the missing values are excluded, resulting in uneven total observation numbers for the two groups in Table1..

⁷ In Strebulaev and Yang (2013), the related results are shown in the logistic analysis on the almost zero-leverage firms, which are defined as the firms with leverage less than 5%..

⁸ The logistic analysis of the enter/exit decision does not separately account for the non-NPND policy as PND and zero-leverage. This may blur the potential possibilities that the firms turn to the NPND from zero-leverage and those from the PND may have different motivations, and also when abandoning the NPND. These possibilities will be discussed in the following sections..

⁹ In an unreported analysis, the Payout-constrained dummy is replaced by a Dividend-constrained dummy. The results are not significantly different from the Payout-constrained dummy version.

¹⁰ The value of the SA-index is positively related to the degree of financial constraints, which is calculated as $-0.737\times Size+0.043\times Siz{e}^2-0.040\times Age$.

¹¹ Dang (2013) finds similar results and explains that this (in the view of financial constraint hypothesis) comes from the correlation with firm size, and provide an alternative baseline regression without firm size in which the coefficient of age becomes negative. However, in the unreported analysis, after removing the firm size from the baseline regression, the results of firm age are still positive.

¹² Strebulaev and Yang (2013) analyse the entry/exit decision of having gross leverage less than 5% using the data of American firms and find that the coefficients of dividend-payer are significantly negative for both entry and exit decisions. Dividends are significantly positive for entry decisions and significantly negative for exit decisions. They argue that most low-leverage firms are dividend-payers, and dividend-paying zero-leverage firms pay substantially higher dividends than the proxies chosen by industry and size..