​Free Cash Flow, Business Risk, and Non-Debt Tax Shield Effects on Debt Policy

Abstract

This study examines the effects of free cash flow, business risk, and non-debt tax shield on the debt policy of food and beverage subsector companies listed on the Indonesia Stock Exchange for the 2021-2025 period, drawing on agency, trade-off, and pecking order theories. Of the 48 companies selected through purposive sampling, one company with negative equity throughout the period was excluded, yielding a balanced panel of 47 companies and 235 firm-year observations. Debt policy was measured by the Debt-to-Equity Ratio (DER), free cash flow by operating cash flow minus capital expenditure and the change in net working capital scaled by total assets, business risk by the rolling standard deviation of the operating profit margin, and non-debt tax shield by depreciation expense scaled by total assets, with firm size, profitability (Return on Assets/ROA), tangibility, and sales growth as control variables. After winsorization at the 1st and 99th percentiles, the Chow, Breusch-Pagan Lagrange Multiplier, and robust Hausman tests favored the random effect model, which was estimated with firm-clustered robust standard errors. Free cash flow (coefficient=-7.517, p=0.712) and non-debt tax shield (coefficient=827.908, p=0.308) have no significant effect on debt policy, whereas business risk has a positive effect (coefficient=395.951, p=0.045) that is not robust across alternative specifications. The three variables are not jointly significant (F=1.388, p=0.247). Profitability is negatively related (p=0.043) and firm size positively related (p=0.016) to debt policy. The evidence favors the pecking order explanation, in which internally generated profits, rather than free cash flow, reduce reliance on debt.

Keywords

Business Risk Debt Policy Free Cash Flow Non-Debt Tax Shield Panel Data Pecking Order Theory