I am not sure if it has not been mentioned but one theory is that a company usually in IT does not have enough assets for collateral.

I don't think a theory exists; the question looks more like historical incident.

In my personal experience, some firms grow from very little dimensions when the entrepreneur's capital suffices; successful enterprises thus "learn" to prosper wihout debt or close. This can be a necessary outcome when the economy falls into general credit shrinkage, with too high request of collateral to collect credit at a sustainable interest rate. I mean, the environment can work as a constraint to forcing certain sectors to grow on own capitals.

To test this, enterprises should be categorised by their Birth year, and controlling by the credit stance of the economy.

It is possible to argue an economic benefit of zero debt, though much of the argument today resides in macroeconomic observarions, and the supporting economic risk theory is only being developed.

Besides the distress cost situation mentioned above, we have seen that financially solid companies have come strengthened through the financial crisis, and the debt heavy companies have suffered most.

While some might argue that financial chris only rarely occur, and that we cannot base a business strategy on such events, in reality the observations point to a much more fundamental problem of risk.

Having debt introduces an extra risk - and potentially many. Currency risk, interest risk, and bankruptcy risk (of bank) is examples. For short term growth such factors can be estimated and be included in business cases and such. But for long term growth activities, it simply becomes factors that reduce the probability for succes of the long term growth.

So it can be argued, that zero debt companies have a more favourable point of departure for long term growth.

In such this line of thinking is supported by Bowmans paradox and many other observations.

But the exact economic theory behind this economic mechanism is not yet out there. But our documentation of the effect of risk on long term investments has been published (see link)

Article Risk, resources and structures: Experimental evidence of a n...

A lot of start up debt is just hidden equity from PE covenants.

Zero debt companies are mainly able to posit superior performance based on lesser requirements of transparency and lesser chance of loss of control. (Being "PRIVATE" is key to keeping higher trajectory of growth) 

The Pecking order theory does posit that Preference for internal funds > Preference for debt > Preference for Equity..

Even within equity otherwise Rights issues to existing shareholders further reward existing shareholders. than bring in new shareholders. (no theory except maybe the MM model)

 Reference: Brealey & Myers/ Brealey Myers and Allen. 

Research available measures preferences of bank managers in issuing debt , which is also a inferential leaning on companies preferences ( Pecking Order) or Game Theory / Decision making preferences of CFOs between debt and equity where you would be extending research by including zero Debt. 

Jensen and Fama's work on Corporate Finance thoery ( also a book reference of the same name) may be instrumental in bringing these views together.

@Amit Mittal

I add the transparency problem has been treated also by the famous Fama-Miller: to remain poorly disclosured you can prefer bank debt instead of open market bond, which means a different kind of debt, but debt anyway, to manage your private information.

@Jesper Lyng Jensen

I add that business (and credit) cycle can inflate indebtness (via low interest rates and Central Bank stimuli); the comparison to post-crisis (and post-deleveraging) situation made of "survivors" may thus look more striking.

Turning your question around, given its tax advantage as pointed out by Modigliani & Miller, why don't companies always seek to maximise debt in their capital structure?  In the 1990s a US firm called Long Term Capital Management did exactly that, even employing two Nobel Prize winners, with disastrous consequences.  See also Brimelow, 2000, When genius failed.

What if those companies do not need loans? Some businesses may generate enough resources for self-financing, and if their marginal cost have reached average cost increasing the production (activity level) will only decrease profits.

Also, some entrepreneurs value their independence more than increasing profits. They do not want to be exposed to banks practice and share their profits with them.

Sometimes banks procedures classify some companies as high risk, so they avoid lending them money, or, demand outrageous conditions, despite positive financial results and history.

just read Modigliani Miller theorem, Meyer hypothesis and read Rajan  and Zingales what do we know about capital structure puzzle 1990

I am quite agree with the suggestion of Dr. Bernard Paranque about the existing theories on Capital Structure puzzle. In connection to this question, I would argue that capital structure of a firm depends on firm's earning capability to absorb the incremental risk  due to addition of new debt in capital structure. It also depends on management's risk taking behavior and the lender's opinion about the firm's internal strength.

Let us assume we are not dealing with Sharia compliant companies which have no debt then we can start with an all equity entity where all shares are the same class and every stockholder has the same number of shares.

As we move from this unrealistic abstraction various powers emerge in terms of blockholdings and this results in principal - principal agency costs. What is the incentive to reduce control through the introduction of non-ordinary shares (common stock) with a form of preference share which tend have reduced voting rights and less risk and in essence incorporate an element of lending to the company.  A step further is to introduce debt.  This leverages equity returns, introduces financial risk and monitoring by the lender.

The increased return might not be worth the reduction in control which might reduced the potential for expropriation of profits which is characteristic of PP agency cost.

There is a nice empirical question to investigate.  Do all equity firms exhibit earnings management and or PP agency costs?

I am going to theorize based on what I am seeing in a rapidly developing country.  In this environment, let us assume that we are talking about somewhat of a traditional company, the management skill of which exists but not that of an aggressive or cutting edge technology company.  The owner managers are not familiar with businesses that will have a long life, diversified enough to weather economic downturns and bad business years or a switch/transition into new technology.  There experience with long lived businesses does not exist. These owners are very fearful of losing the business (control, if you will) and shy away from debt financing.  A owner manager who has a sufficiently long experience, probably also have a bitter memory and will not tread that path.  Those with shorter experience do not have the skill to manage risk.  Add to that the necessity of paper work and compliance issues associated with debt financing.  I suspect that companies with longer life and acquired management skill in a developing country will show greater propensity to use debt.

Because the capital cost for debit is too high mainly in emergent market like Brazil.

Dear Stuart Locke,

Sharia compliant companies are allowed to have debt. Debt is not forbidden under Sharia, but interest (riba). Based on the method of financing chosen under Sharia law,  the cost of borrowed capital is determined either as profit share, extra cost of purchasing, discount on sales, or rent. However, they may not be recognized in accounting as financial costs, but as operational costs, complicating the calculations of the capital cost.

Best regards

Bradut Bolos PhD

As far as the theories of capital structure (mixture of different sources of capital) is concerned, they have evolved over time to include the beneficial shield form taxes on the interest payments of the debt. On the one hand we have theories of irrelevancy where the capital mix does not have any impact on firm's value (which of course excludes the tax shield advantage from debt) and on the other we have bankruptcy costs of amassing more and more debt. A logical  solution point on these two extreme points on the continuum of theories would be the trade off theory (which weighs the cost and benefit of taking extra debt). 

Real world observation shows that this is quite a sector specific phenomenon, where IT firms, service oriented industries generally does not go for much debt, but you have capital intensive firms in mining, construction which are loaded with debt. One possible explanation for tons of debt by capital intensive industry could be their possession of fixed assets, that can be used as collateral for debt.  

Dear Prof. Stuart Locke,

I would like to comment on a statement quoted from your answer:

 "Let us assume we are not dealing with Sharia compliant companies which have no debt"

Sharia compliant companies can have debt normally, the problem is in the interest , for example in the Sharia screening methodology applied to figure out if a company is Sharia compliant or not ; we have to calculate the level of debt ratio and interest ratio that are financed from conventional financial institution and should not exceed a specific thresold, but if they are from Islamic financial institution then there is no problem. Another relevant point is the financing mechanism for companies from a sharia compliant prospective could be either equity based mechanism like mudaraba or musharaka or debt based mechanism like murabaha , ijara, salam, or istisnaa.

To conclude; Sharia compliant companies could have debt, and their capital structure could have normally equity and debt.

I hope this was of helpful clarification.

Thanks.

Best Regards,

Maha

Your question is interesting. I never found companies with zero debts (financial and nonfinancial debts), but is likely to exist. However, I do not think there is a theory that explains this phenomenon. If anything, there is the theory of the irrelevance of financial structure (M&M, 1958). There may be the theory of capital structure (J&M, 1976), and the free cash flow (Jensen, 1986). Still, there may be the pecking order theory (Donaldson, 1961; Myers and Majluf, 1984). You can also find interesting the article by Rajan and Zingales (1995).

Future is Uncertain as about debt is concerned a Company cannot rely on debt because the company has to pay the Interest amount on debt with its stated principal amount . Zero debt poses no risk on an company's Capital structure and Company can stuck its fund the case may be if there is not profit then Company has no implication on its Payment obligation. Where as on the other hand as per debt is Concerned the debenture holders can force the company in to liquidation. No debt no outsiders burden and no outsiders burden no risk of default in Payment and at last no threat of liquidation which can bring an end to the Company's existence.Although to raise debt is necessary because of leverage and if debt used with the optimum capacity can give fruitful results and at last better Debenture holder Confidence.

Probably, because some company has no certainty about the income which is required for payment of fixed return on debt capital.

Agency theory suggests that increasing debt increases the monitoring of the company lowering agency costs, and with fixed commitments for debt servicing management has less free cash flow with which to "play".

In closely held businesses, small or large, no debt provides the majority shareholder the opportunity to expropriate earning (PP Agency cost) and to benefit from extra company supported perks (PA agency costs)

  A potentially fruitful line of research is to investigate the ownership and governance structures for non debt companies.  There will always be anomalous examples but a initial sample, 20-30 firms, would be enough to get a statistically significant finding.

One theory that predicts this is the so-called negative debt capacity of growth options. Some firms expect to need lots of internal resources to be able to exercise their growth options in the future, and the benefits of debt relative to market or book value is lower for those firms. 

It could also be the result of a theory of product market competition where firms need to save all their debt capacity and even accumulate cash to ward of potential entrants into their area of core competency, or to be ready to compete for participation in  new product markets that might appear in the future.

Dear Matemilola,

As far as I know this is going to be a question of concentration for researchers in upcoming time.  Non of the theories of capital structure can explain this phenomenon.  It somebody tries to it would be exaggeration  out of exaggerated theories. Only one theory explains this situation.  "Theory of Equity and Sustainability."

In the world does not exist no one theory that of the reason why of a capital structure with debt zero ( 0 ). Besides, out of the decision of a silly multimillionaire investor to have his companies without debt any, no other valid argument been worth that you back that decision does not exist . Let's not forget the old saying that “TTHE BIGGER PROFITABILITY TO THE INVESTOR IS PRODUCED WORKING WITH THE MISTER'S MONEY” (with not our own money)  That is, any company with 100 % of indebtedness, if it generate superior profits to the total service of the debt, will produce an infinite TIRM to the investor. That's why, the best level of indebtedness is that one that generate utility after taking care of the total service of the Company debt.

I suggest this article:

Strebulaev, I.A., and Yang, B. (2013), “The mistery of zero-leverage firms”, Journal of Financial Economics, Vol. 109, No. 1, pp. 1-23.

Interesting question posed

Some thoughts below

https://www.researchgate.net/publication/276027948_ICT_in_Small_and_Medium_Enterprises

Technical Report ICT in Small and Medium Enterprises