Does it Pay to Invest in Debt Free Firms During Recessions?

Abstract

This study examines the impact of leverage on equity returns of large cap firms during
recessionary periods. We examine whether large cap firms that carry no debt on their balance sheet are rewarded during recessions. We compare the performance of portfolios of debt free firms to comparable portfolios of leveraged firms during the period of the last recession, December 2007-June 2009. The results of the study indicate that investments in portfolios of large cap debt free firms tend to generate higher returns than investments in their leveraged peers. These results imply that investors tend to reward firms that resist the urge to borrow heavily and operate with a debt free balance sheet during recessions and to penalize firms that have high levels of debt.