Abstract
This study attempts to find out whether investors reward firms that carry no debt and penalize firms that carry large amount of debt during recessions. I compare the performance of portfolios of large cap debt free firms to comparable portfolios of leveraged firms during the last recession. The results of the study suggest that investments in portfolios of debt free firms tend to generate higher returns than investments in portfolios of leveraged firms during recessions. The evidence presented here has clear implications for investors and portfolio managers. During market downturns, debt free firms will not have the additional burden of debt and may be able to recover much quicker than leveraged firms, and therefore they would outperform their peers of leveraged firms. Investors would therefore be better off if a larger portion of their equity investment is allocated to debt free firms rather than leveraged firms.
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