Unraveling the Impact of Product Market Competition and Earnings Volatility on Zero Leverage Policies

Abstract

This thesis investigates the relationship between product market competition and zero leverage behavior within firms, aiming to uncover how these dynamics interact. Additionally, it explores whether firms characterized by higher earnings volatility exhibit a more pronounced positive relationship between product market competition and the likelihood of adopting a zero-leverage strategy. To carry out this investigation, we employed product market competition data (Fluidity) from the Hoberg-Phillips Data Library and financial data from the Compustat (North America) database, spanning from 1989 to 2019. As product market competition intensifies, the probability of firms adopting a zero leverage policy increases. Furthermore, our research illuminates that the positive impact of heightened product market competition on the likelihood of zero leverage policies is accentuated in firms characterized by elevated levels of earnings volatility. This finding corroborates our initial hypothesis, substantiating the notion that increased competition significantly influences a company's earnings volatility. We also strengthened our analysis with insights from existing literature, underscoring how heightened earnings volatility intensifies the propensity to embrace a zero leverage policy. This study contributes insights to the literature, notably as the first to employ the interaction term between product market competition and earnings volatility in exploring these financial dynamics.