Deleveraging to the Extreme: what Really Motivates the Trend in a Developing Economy?

This paper examines the role of financial flexibility, financial constraints, and the establishment of networks through the presence of a business group to explain the extreme corporate deleveraging phenomenon. Using a sample of listed Pakistani firms between 2010 and 2018, this study uses binary response models such logit regression and instrumental variable probit methods to examine the motivations of debt-free firms. Financial flexibility, financial constraints, and business group affiliations significantly increase the propensity for extreme corporate deleveraging policies. These results show that corporate deleveraging policies in Pakistan are not only justified by one single explanation. Demand-side arguments justified by the search for financial flexibility and supply-side arguments justified by severe conditions imposed by creditors to grant debt may explain the zero-leverage trend in Pakistan. A business group-affiliated firm is able to obtain more knowledge, capital and information from the group, which reduce their dependence from the market. A consequence is that business groups-affiliated firms can avoid the market imperfections and information asymmetries, thus being more prepared to build up financial flexibility and avoid the need to resort to debt than a stand-alone firm.