Corporate liquidity and dividend policy under uncertainty |
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| Institution: | 1. Department of Economics, Finance and Accounting, Frederick University Cyprus, 7 Frederickou Street, Nicosia 1036, Cyprus;2. Department of Accounting and Finance, University of Cyprus, P.O. Box 20537, CY 1678 Nicosia, Cyprus;3. Department of Accounting and Finance, University of Cyprus, P.O. Box 20537, CY 1678 Nicosia, Cyprus; School of Management and Business, King''s College London; and Sloan School of Management, MIT;1. Universidad Pública de Navarra, Spain;2. Universidad CEU Cardenal Herrera, Spain;1. HEC Montréal, 3000 Chemin de la Côte-Sainte-Catherine, Montréal Québec H3T 2A7, Canada;2. Université de Sherbrooke, 2500 Boulevard de l''Université, Sherbrooke Québec J1K 2R1, Canada;1. Binghamton University, AA210, School of Management, Binghamton, NY 13902, US;2. University of Michigan Law School, 1039 Legal Research, Ann Arbor, Michigan 48109, US |
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| Abstract: | We examine optimal liquidity (retained earnings) and dividend choice incorporating debt financing with risk of default and bankruptcy costs as well as growth options under revenue uncertainty. We revisit the conditions for dividend policy irrelevancy and the broader role of retained earnings and dividends. Retained earnings have a net positive impact on firm value in the presence of growth options, high external financing costs and low default risk. High levels of retained earnings enhance debt capacity but have a negative effect on equity value due to the likelihood of losing accumulated cash balances in case of default, unless offset by high external financing costs. Opposite directional effects of retained earnings on equity and debt create a U-shaped relation with firm value. The framework is extended to analyze management-shareholder conflicts, demonstrating that managers accumulate higher than optimal cash. |
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