On Modified DuPont Method: Analysis of Firms with Negative Net-Financial-Obligations

Posted: 12 Dec 2016 Last revised: 7 Jan 2018

See all articles by Xiao-Jun Zhang

Xiao-Jun Zhang

University of California, Berkeley; China Academy of Financial Research (CAFR)

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

Zhang, Xiao-Jun, On Modified DuPont Method: Analysis of Firms with Negative Net-Financial-Obligations (November 1, 2016). Available at SSRN: https://ssrn.com/abstract=2870785 or http://dx.doi.org/10.2139/ssrn.2870785

Xiao-Jun Zhang (Contact Author)

University of California, Berkeley ( email )

545 Student Services Building
SPC 1900
Berkeley, CA 94720
United States
(510) 642-4789 (Phone)
(510) 642-4700 (Fax)

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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