Author(s): David Caban
This paper investigates if all-equity firms are a heterogeneous group as it relates to accounting quality. All-equity firms are a unique group of firms that choose a “corner solution” as their capital structure. Extant research supports the argument that poor accounting quality makes debt so prohibitive that such firms are driven to this capital structure. This paper proposes that an all-equity structure is not necessarily symptomatic of poor accounting quality overall and in fact, some high accounting quality firms choose to preclude debt from their capital structure. The paper investigates if different motivations, within an all-equity setting, associated with free cash flows and growth opportunities, result in different levels of accounting quality. By anchoring on theories that link implicit costs of debt to free cash flow levels and growth opportunities, this study hypothesizes that free cash flows and growth opportunities are strongly linked to the justification or lack thereof for the pursuit of an all-equity capital structure. This study hypothesizes and shows that firms in the extremes of the free cash flow to growth rate spectrum exhibit significantly different levels of accounting quality when compared to their levered peers. These results support the main prediction that there exist accounting quality differences within the all-equity setting, associated with free cash flow levels and growth opportunities, and motivating the use of such structure. Thus, the pessimistic conclusions for pursuing an all-equity strategy reached by prior research should not be generalized to all such firms.