Optimal Dividend Policy Research Articles

CORPORATE LIQUIDITY, DIVIDEND POLICY AND DEFAULT RISK: OPTIMAL FINANCIAL POLICY AND AGENCY COSTS

We study the simplest discrete-time finite-maturity model in which default arises when the firm is not able to pay its debt obligation using the current cash-flow plus the corporate liquidity. An important distinction is made between liquidity and solvency of the firm. The corporate financial policy is simultaneously defined by the dividend policy, and the leverage policy (the coupon and the principal of the bond). When the corporate financial policy implies no default risk and no taxes, we show that the corporate financial policy is irrelevant and this irrelevance result holds for any probability measure. When the corporate financial policy implies now some default risk, we show that the value of the firm is a piecewise decreasing function of the dividend policy for any leverage policy, so that dividend policy affects the value of the firm. However, shareholders may not always have the incentives to implement this optimal dividend policy. We show that when the value of the assets is low, shareholders have an incentive to deviate from this optimal dividend policy, and we also study the resulting agency costs. We finally compare the resulting quantities of our model to the base case suggested by Huang and Huang (2003).

OPTIMAL DIVIDEND PAYMENTS WHEN CASH RESERVES FOLLOW A JUMP-DIFFUSION PROCESS

We consider a model in which a firm faces two types of liquidity risks: a Brownian risk and a Poisson risk. The firm chooses a dividend policy to maximize shareholder value. We characterize the optimal firm value and we show that the optimal dividend policy is a barrier strategy: the firm keeps cash inside when the cash reserves level is less than a critical threshold and pays cash in excess of this threshold. We also analyze the problem of insurance against the Poisson risk. We find that it is optimal for the firm to buy full insurance when its cash reserves are above a critical threshold and not to insure otherwise.

Optimal dividend payments in the stochastic Ramsey model

We consider the dividend payments of a self-financing firm in the stochastic Ramsey model. The firm invests in capital stock and its production technology is given by the Cobb–Douglas function. Our objective is to maximize the expected present value of future real dividends subject to a positive constraint on the capital stock. We use the penalization method to obtain a solution for the variational inequality associated with the optimal growth problem and give a synthesis of the optimal dividend policy.

Optimal Dividends and ALM Under Unhedgeable Risk

In this paper we develop a framework for optimal investment decisions for insurance companies in the presence of (partially) unhedgeable risk. The perspective that we choose is from an insurance company that maximises the stream of dividends paid to its shareholders. The policy instruments that the company has are the dividend policy and the investment policy. Using stochastic control theory, we derive simultaneously the optimal investment policy and the optimal dividend policy, taking the insurance risks to be given. We study the trade off between investing in the optimal hedge portfolio and the fully diversified portfolio. We show next how the pricing of unhedgeable risk can also be embedded in our framework. Finally, we derive the distribution of the time of bankruptcy and demonstrate its usefulness in calibrating the model.

Optimal Dividend Policies with Transaction Costs for a Class of Diffusion Processes

Finding optimal dividend strategies is a classical problem in the financial and actuarial literature. The idea is that the company wants to pay some of its surplus as dividends, and the problem is to find a dividend strategy that maximizes the expected total discounted dividends received by the shareholders until ruin. Here we generalize results in [J. Paulsen, Adv. Appl. Probab., 39 (2007), pp. 669-689] in that the rate of growth of the surplus process is assumed to exceed the discounting factor whenever the surplus process is smaller than a fixed number $x_{\lambda}$. In [J. Paulsen, Adv. Appl. Probab., 39 (2007), pp. 669-689] it was assumed that this rate of growth is always less than or equal to the discounting factor. It turns out that this generalization makes the problem much more complicated, and a simple barrier strategy is no longer always optimal.

Costly Financing, Optimal Payout Policies and the Valuation of Corporate Debt

We present a cash-flow based model of corporate debt valuation that incorporates two novel features. First, we allow for the separation and optimal determination of the firm's debt-service and dividend policies; in particular, the firm is allowed to maintain cash reserves to meet future debt obligations. Second, our model admits the possibility that raising resources through issuance of new equity could be a costly procedure. In contrast, much of the previous literature has considered only dividend polices that are the consequences of debt-service policy, and has assumed new equity issuance costs are either zero or infinite. We provide an analytical characterization of equilibrium behavior in our model. Numerical analysis of the equilibrium reveals that our model predicts substantially higher yield spread than the canonical Merton-type model. More importantly, we find that the two novel features of our model are crucial determinants of not only the overall spread that result but also of the marginal impact of allowing for debt-service to be strategic. Specifically: (a) assuming residual rather than optimal dividend policies can result in a significant upward bias in the yield spread predicted by the model; (b) the size of this bias depends in a central way on the costs of equity issuance; (c) the marginal impact of strategic debt-service is substantial, in general, only for low equity-issuance costs, and (d) under optimally-determined dividends, strategic debt-service can actually result in a narrowing of yield spreads. In summary, our results indicate that endogenizing dividend policy and allowing for equity-issuance costs can enhance the model's content substantially, while ignoring these factors could introduce non-trivial biases into the valuation.

Classical, Singular, and Impulse Stochastic Control for the Optimal Dividend Policy when There is Regime Switching

Motivated by economic and empirical arguments, we consider a company whose cash reservoir is afiected by macroeconomic conditions. Speciflcally, we model the cash reservoir as a Brownian motion with drift and volatility modulated by an observable continuous-time Markov chain that represents the regime of the economy. The objective of the management is to select the dividend policy that maximizes the expected total discounted dividend payments to be received by the shareholders. We study three difierent cases: bounded dividend rates, unbounded dividend rates, and the case in which there are flxed costs and taxes associated to the dividend payments. These cases generate, respectively, problems of classical stochastic control with regime switching, singular stochastic control with regime switching, and stochastic impulse control with regime switching (a new problem in the stochastic control literature). We solve these problems, and obtain the flrst analytical solutions for the optimal dividend policy in the presence of business cycles. Our results show, among other things, that the optimal dividend policy depends strongly on macroeconomic conditions.

Corporate Liquidity, Dividend Policy and Default Risk: Optimal Financial Policy and Agency Costs

We study the simplest discrete-time finite-maturity model in which default arises when the firm is not able to pay its debt obligation using the current cash-flow plus the corporate liquidity. An important distinction is made between liquidity and solvency of the firm. The corporate financial policy is simultaneously defined by the dividend policy, and the leverage policy (the coupon and the principal of the bond. When the corporate financial policy implies no default risk and no taxes, we show that the corporate financial policy is irrelevant and this irrelevance result holds for any probability measure. When the corporate financial policy implies now some default risk, we show that the value of the firm is a piecewise decreasing function of the dividend policy for any leverage policy, so that dividend policy affects the value of the firm. However, shareholders may not always have the incentives to implement this optimal dividend policy. We show that when the value of the assets is low, shareholders have an incentive to deviate from this optimal dividend policy, and we also study the resulting agency costs. We finally compare the resulting quantities of our model to the base case suggested by Huang and Huang (2003).

Dynamic Asset-Liability Management for Defined-Benefit Pension Plans

A dynamic asset-liability management model for defined-benefit pension plans is developed. The plan can be in surplus or deficit. The sponsor is loss averse and tolerates limited shortfalls in assets under management relative to the liability due. The optimal contribution policy, the optimal dividend policy and the associated asset allocation rule are derived and analyzed. Sound Asset-Liability Management is shown to entail future withdrawals from as well as future contributions to the pension fund, even if the current funding shortfall is large. The impact of model parameters, such as contribution capacity, shortfall ratios tolerated, risk aversion and loss aversion, is examined. Wealth effects are found to be critical for the properties of asset allocation rules.

On the Optimal Stochastic Impulse Control of Linear Diffusions

We consider a class of stochastic impulse control problems of linear diffusions arising in studies considering the determination of optimal dividend policies. This class of problems appears also in studies analyzing the optimal management of renewable resources. We state a set of weak conditions guaranteeing both existence and uniqueness of the boundary characterizing the optimal policy and its value. We also analyze two associated stochastic control problems and establish a general ordering for both the values and the marginal values of the considered stochastic control problems. In this way we extend previous findings obtained by relying on linear payoff characterizations.

Do liquidity induced changes in aggregate dividends signal aggregate future earnings growth?

Extant empirical literature does not provide abundant evidence for the information content hypothesis regarding firm-level dividend signaling. Although this is consistent with the argument against an optimal firm-level dividend policy, this does not imply an absence of an optimal aggregate dividend level. Aggregate dividends and earnings may exhibit stronger associations if aggregation filters out firm-specific earnings information and indicates macroeconomic trends. Using macroeconomic data, we show that aggregate payout ratios signal aggregate future earnings growth for horizons up to 4 years, and that excess aggregate liquidity plays an important role in this relationship.

The Firm's Financing and Dividend Policies, and the Cost of External Financing Under Information Asymmetry: A Generalized Analysis

Extant Information Asymmetry (IA) theories in corporate finance apply, not to all but, only to that subset of firms satisfying the theories` assumptions about: a) the nature of the manager`s private information, and b) the set of securities that can be issued. The research has noted that the conflicting empirical results in the literature my stem from the fact that the firms under study may not satisfy these assumptions. We therefore examine, in this paper, the implications of IA for the firm`s optimal financing and dividend policies, and the cost of external financing, in a framework that accommodates all natures of the manager`s private information and that places only parsimonious restrictions on the set of securities that the firm can issue. We show, using a screening model, that irrespective of the assumptions one makes about the nature of the manager`s private information, and the set of securities that can be issued, a firm will belong to one of three IA Groups, and that IA has similar implications for all firms within a Group. This surprising finding, not only yields extant IA results as special cases of our generalized framework, but it also generates new results for the firm`s optimal financing /dividend policies and reverses some standard debt-equity intuitions. For example, we find, contrary to the implications of the extant theory, that: a) firms can issue equity and, in some cases, issuing equity can be optimal when even it is accompanied by a drop in stock prices, b) equity issuance may be optimal even there is IA only about firm value and not variance, c) an increase in IA, even about value, can lead to an increase in equity issuance, and d) firms can optimally pay dividends and issue risky securities, even equity. These new results also help us reconcile some conflicting findings of the extant IA empirical research. Finally, our approach provides a rich agenda for future research. It provides suggestions for : i) conducting more powerful empirical tests on the impact of IA on the firm`s optimal policies, ii) identifying new securities (security design) that while reducing external financing costs are also likely to attract a broad-based demand from firms and iii) identifying the firm`s optimal financing/dividend policies when it can issue securities such as convertibles.

Optimizing venture capital investments in a jump diffusion model

We study two practical optimization problems in relation to venture capital investments and/or Research and Development (R&D) investments. In the first problem, given the amount of the initial investment and the cash flow structure at the initial public offering (IPO), the venture capitalist wants to maximize overall discounted cash flows after subtracting subsequent investments, which keep the invested company solvent. We describe this problem as a mixture of singular stochastic control and optimal stopping problems. The second problem is concerned with optimal dividend policy. Rather than selling the company at an IPO, the investor may want to harvest technological achievements in the form of dividend when it is appropriate. The optimal control policy in this problem is a mixture of singular and impulse controls.

Vliv teorie zastoupení na teorii podnikových financí

Teorie zastoupeni se v literatuře poprve objevila v 70. letech v dilech Rosse (1973) a Jensena s Mecklingem (1976). Jejimi východisky byly transakcni naklady, asymetricke informace, moralni hazard a nepřiznivý výběr. Postupně se tato teorie prosadila nejen v ekonomických vědeckých disciplinach, ale např. i v sociologii a politologii. Z hlediska financi podniku se jako nejdůležitějsi pro rozvoj teto discipliny jevi vliv nakladů zastoupeni na tržni hodnotu firmy. Významne misto ma tato teorie i při vysvětlovani optimalni kapitalove struktury a dividendove politiky. Rovněž v ceske odborne literatuře se objevuje stale vice zastanců teto teorie.

Optimal dividend policy and growth option

We analyse the interaction between the dividend policy and the decision on investment in a growth opportunity of a liquidity constrained firm. This leads us to study a mixed singular control/optimal stopping problem for a diffusion that we solve quasi-explicitly by establishing a connection with an optimal stopping problem. We characterize situations where it is optimal to postpone the distribution of dividends in order to invest at a subsequent date in the growth opportunity. We show that uncertainty and liquidity shocks have an ambiguous effect on the investment decision.

The Development of Company Dividend Policy in Respect of Profit Distribution

The selection of optimal dividend policy is one of the main questions in the company’s financial management strategy as well as the indicator of investment attraction increase instruments and financial situation change. Although this subject has been discussed by scientists from various countries for more than 40 years, it has not been surveyed so far what decisions of company profit distribution are the most rational in respect of both the company itself and investors. There is no general opinion if it is worth for the company to pursue strategically formed dividend policy and if it is so, then what dividend policy should be selected by the company seeking its strategic aim – the maximization of the company value and shareholders’ benefit. Scientists from numerous countries usually deal with effective profit distribution problems in respect of distinct interest groups. Their works lack a systemic research on dividend policy development subject to the priorities of profit distribution. Therefore, the research object of this article is the formation of dividend policy in respect of profit distribution priorities. The aim of the research is to develop a model of company dividend policy estimating profit distribution priorities. Dealing with the problem of dividend policy formation in respect of profit distribution priorities, profit distribution and dividend policy alternatives as well as measures company’s profit distribution priorities which influence the selection of dividend policy are analysed in the article. Moreover, according to the investors’ preference given to the current and future consumption, a comparative analysis of company’s dividend policy models is carried out. Having performed the analysis of profit distribution and dividend policy alternatives, it was found that dividend policy is selected on the basis of who – shareholders or company’s managers – have higher influence on the formation of dividend policy. It also depends on what consumption – current or future – is preferred by investors. Companies, having chosen residual dividend policy, re-invest their profit on condition that profitability of re-investment is higher (or equal) than the profitability from alternative investment of similar risk level. The company seeking to implement new investment and to maintain the proper structure of shareholders as well as financing with external capital tends to develop residual dividend policy. Meanwhile the company forming its dividend policy according to the model of stable and constantly growing dividends, prefers to retain the reliability of current dividends, to ensure a small degree of uncertainty in the formation of dividend policy as well as to preserve the stability of dividend growth rate. According to the stable dividend payout ratio model, dividend policy formation is conditioned by priorities, given to the stability of profit, the stability of the payout ratio and high degree of informativeness on the financial state of the company in the market. Low stable dividend and premium payout policy at the end of the year are a compromise dividend policy between stable dividends and their constant payout standard. Although priorities which the company gives to low dividend payout stability, distinctive shareholders’ interest group compatibility, dividend payout flexibility as well as high degree of informativeness of the market highly influence the selection of this policy, the main disadvantage is that dividend instability causes dissatisfaction among the investors.

Investment policy with heterogeneous beliefs of investors

The theoretical work on the dividend policy of a firm suggests five imperfections that management should consider. Different from these five frameworks, our theoretical work develops a model regarding an optimal investment–dividend policy to maximize a firm's value with divergent types of shareholders. The results show that an optimal dividend policy does exist under a heterogeneous beliefs framework.

A class of solvable stochastic dividend optimization problems: on the general impact of flexibility on valuation

We consider the determination of an optimal dividend policy in the presence of cash flow uncertainty and transaction costs. We state a set of weak conditions under which the optimal dividend policy can be explicitly characterized for a broad class of diffusions modelling the underlying cash flow dynamics and demonstrate that increased dividend policy flexibility does not only increase the maximal expected cumulative present value of the future dividends, it also increases the rate at which this value grows (i.e. Tobin’s marginal q). We also prove that increased transaction costs result into larger but less frequent dividend payments.

Incentives, Financial Policy and Compensation Contracts

This paper illustrates an incentive-aligning role of financial policy in the presence of optimal compensation contracts. Due to information asymmetry, value-maximizing compensation contracts provide managerial rents when high states of nature are realized. The manager has an incentive to increase these rents by choosing investments that generate greater information asymmetry. An aptly chosen debt level mitigates this incentive, because investments that generate greater information asymmetry also increase payoff volatility. The greater volatility would make the debt risky, causing the shareholders to focus on high states of nature, and therefore compensation contracts that reduce managerial rents. The optimal financial policy balances the manager's incentive to choose opportunistic investments and the shareholders' incentive to offer contracts that focus excessively on high states, despite the cost to bondholders. An endogenous feature of this balance is that the bondholder expropriation conflict is of greatest concern when the firm performs poorly, and manager-owner conflict is of greatest concern when the firm is doing well. The shareholder-bondholder conflict is effectively controlled via short-term debt obligations (service payments and covenants) and the manager-owner conflict is effectively controlled via short-term dividend policy. The optimal capital structure and dividend policy provide additional insight into empirical patterns and suggest interesting directions for future research.

Dividends, safety and liquidation when liabilities are long-term and stochastic

This paper investigates the optimal management of a firm faced with a long-term liability that occurs at a random date. Three issues are analysed: The optimal dividend policy; optimal expenditure on safety to delay the occurrence of the liability; and the optimal liquidation date of the firm. An owner faced with dynamic unlimited liability never liquidates and therefore accumulates capital to the golden rule level. For long-term liabilities, dividend payments and safety expenditure are non-decreasing over time. The owner protected by limited liability may liquidate the firm in finite time in order to avoid paying the liability. If this is the case, then it accumulates less capital than the dynamic unlimited liability owner; and may decrease dividend payments and safety expenditure over time. The paper shows that a finite liquidation date is more likely to be optimal when the arrival rate of the liability occurrence increases over time.