Debt Conservatism and Cash Policy on Emerging Markets

There is a lack of evidence provided by literature to support deleveraging predictions of financial flexibility theory. However, empirically, the majority of the firms tend to reduce their market leverage level and simultaneously increase cash holdings. This study examined whether highly levered firms systematically deleverage to restore flexibility and whether there exists long-term stability of corporate leverage among firms on emerging markets. The sample includes observations for 7 589 public companies from 19 emerging markets for the period of the last 10 years. We found that (1) a typical firm deleverages from peak market leverage to the near-zero leverage level to rebuild financial flexibility; (2) managerial actions (debt repayment, earnings retention, and stock issuance) account for a significant amount of the deleveraging process, (3) financial distress makes firms to fail in reaching low market leverage levels; (4) firms view debt as a tool for financing their operational needs and do not see benefits from having debt permanently in the capital structure. The results support predictions of financial flexibility theory.