Zero leverage and the value in waiting to have debt

This paper documents that the real option to have debt motivates some firms to remain debt-free, even when standard trade-off theory predicts that these firms should have leverage. The real option has a first-order effect similar to the effect of bankruptcy costs in addressing the zero-leverage puzzle: the observation that many firms seemingly forgo sizable debt benefits by remaining debt-free. The debt-free firms’ value includes the option whose value is derived from future debt benefits and hedging bankruptcy costs. This paper proposes an optimal timing model for having debt and finds support for the model’s predictions through calibrations and simulations.