The financial conservatism of firms in emerging economies

Using a large sample of emerging market firms over the period 1980-2015, we document a high prevalence and persistence of financial conservatism. Specifically, 31% of the African firms have ultra-low leverage (less than 5%), with 42% and 11% having non-positive net-debt (total debt less cash) and no debt (zero-levered), respectively. In further analyses, we find that macroeconomic conditions have a muted effect on financial conservatism. Our results suggest that financial conservatism in emerging markets is due to two main factors; (1) credit constraints, and (2) the desire to attain or enhance financial flexibility. The former calls for pro-market policies that improve access to external finance. At the same time, the latter, which results in the accumulation of cash reserves at the expense of current investments, is a strategic choice aimed at preserving or enhancing financial flexibility. Our results are robust to using alternative sub-sampling, model specifications, definitions of variables and estimation techniques.