On Modified DuPont Method: Analysis of Firms with Negative Net-Financial-Obligations
Posted: 12 Dec 2016 Last revised: 7 Jan 2018
Date Written: November 1, 2016
Abstract
We find over 30% of public U.S. non-financial companies have negative net-financial-obligations (NFO) during the sample period of 1965 to 2014. According to the modified DuPont analysis, NFO is defined as total debt minus excess cash and passive investments. The prevalence of these observations casts doubt over the validity of the modified DuPont method, especially the treatment of excess cash and passive investments as negative debt. We explore several reasons for this phenomenon, including weak corporate governance, internal financing, and tax deferral. Overall, the evidence is most consistent with the equity financing and the tax deferral hypotheses, supporting the treatment of excess cash and passive investment as financial assets. However, the results also indicate that it is inappropriate to net these financial assets against debt since they are primarily related to firms’ internal-equity-financing activities as opposed to external-debt-financing activities.
Keywords: Modified DuPont Analysis, Negative Net-Financial-Obligations, Tax Deferral, Internal Financing
JEL Classification: M41, G32, G35, H26
Suggested Citation: Suggested Citation