Dividend Smoothing, Financial Flexibility and Capital Structure

Abstract

This paper investigates the impact of corporate financial flexibility on dividend smoothing. With a novel IV-approach, using the occurrence of US government shutdowns as instrument, we find that dividend smoothing is highly contingent on the firms’ financial flexibility, measured by unused debt capacity and capital structure adjustment speeds. Consistent with Lambrecht and Myers (2012), the observed heterogeneity in dividend smoothing policies is to a large extent explained by the absorptive capacities of the firms capital structure, although severe negative shocks to net income cannot be mitigated by the firms’ financial flexibility.