Abstract
Because of the profitable nature of risk businesses in the long term, de Finetti (1957) suggested that surplus models should allow for cash leakages, as otherwise the surplus would unrealistically grow (on average) to the infinity. These leakages were interpreted as 'dividends'. Subsequent literature on actuarial surplus models with dividend distribution has mainly focussed on dividend strategies that either maximise the expected present value of dividends until ruin or lead to a probability of ruin that is inferior to one (Albrecher and Thonhauser, 2009; Avanzi, 2009). Few papers are directly interested in modelling dividend policies that are consistent with actual practice in financial markets. In this short note, we review the corporate finance literature with the specific aim of fleshing out properties that dividend strategies should ideally satisfy, if the objective of the model was one of practicality.
Highlights
From pioneer work on the modelling of an insurance company’s surplus as a stochastic process in the first half of the 20th century (Lundberg [1], Cramér [2]), substantial theory exists to determine the stability of risky businesses
Criteria include the probability of ruin, and the expected present value of dividends paid until ruin
Since the probability of ruin monotonically decreases when the surplus increases, applying such a criterion should lead companies to let their surplus grow to infinity. This issue was first raised by de Finetti [5], whose goal was to propose an alternative formulation that would be sufficiently realistic and tractable to “study the practical problems regarding risk and reinsurance”. He explicitly allowed for surplus leakages, which were interpreted as dividends
Summary
From pioneer work on the modelling of an insurance company’s surplus as a stochastic process in the first half of the 20th century (Lundberg [1], Cramér [2]), substantial theory exists to determine the stability of risky businesses. Since the probability of ruin monotonically decreases when the surplus increases, applying such a criterion should lead companies to let their surplus grow to infinity This issue was first raised by de Finetti [5], whose goal was to propose an alternative formulation that would be sufficiently realistic and tractable to “study the practical problems regarding risk and reinsurance”. The solution suggested by Allen and Michaely [7] is to look at what is observed in practice In this spirit, this note does not intend to add to the corporate finance literature, but rather summarise its findings in order to flesh out desirable properties. Such payouts can take the form of either dividends (stricto sensu) or share repurchases; see
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
