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. Director of the Accounting and Financial Studies Department, Universidad Icesi Cali Colombia;2. Department of Accounting and Financial Studies, Universidad Icesi Cali Colombia;1. American University, Kogod School of Business, Department of Finance and Real Estate, 4400 Massachusetts Avenue, NW, Washington, DC 20016, USA;2. Birkbeck University of London, School of Business, Economics and Informatics, Department of Management, Malet Street, WC1E 7HX London, UK;3. Yildiz Technical University, Graduate School of Social Sciences, Business Administration, Barbaros Bulvari, 34349 Yildiz, Istanbul, Turkey;1. Rotman School of Management, University of Toronto, 105 St George Street, Toronto, Ontario M5S 3E6, Canada;2. Rowe School of Business, Dalhousie University, 6100 University Avenue, PO BOX 15000, Halifax, NS B3H 4R2, Canada;1. La Trobe Business School, La Trobe University, Australia;2. Department of Accounting, Deakin University, Australia;3. Mifranthe Associates and Emeritus Professor at University of Birmingham, United Kingdom |
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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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