Financial flexibility or financial constraints? Zero-leverage firms during the COVID-19 pandemic

Using a large sample of firms across 42 countries, I analyze the investment and debt financing of zero-leverage firms during the COVID-19 crisis to shed light on the zero-leverage puzzle. I find empirical evidence supporting the hypothesis that the motivation behind zero-leverage capital structure is to preserve financial flexibility. Firms that were zero-levered immediately prior to the pandemic showed a smaller decline in investment and increased their leverage more than the levered firms, after controlling for firm-level characteristics. Empirical evidence suggests that zero-leverage firms utilized their excess debt capacity to raise debt financing to finance the cash flow shortfall and maintain the investment rate during the pandemic. The results also highlight the real effects of financial flexibility during crises and its importance in a firm's capital structure choice.