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Corporate liquidity and dividend policy under uncertainty

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  • Koussis, Nicos
  • Martzoukos, Spiros H.
  • Trigeorgis, Lenos

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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  • Koussis, Nicos & Martzoukos, Spiros H. & Trigeorgis, Lenos, 2017. "Corporate liquidity and dividend policy under uncertainty," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 221-235.
    • Handle: RePEc:eee:jbfina:v:81:y:2017:i:c:p:221-235
    DOI: 10.1016/j.jbankfin.2017.01.021
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    More about this item

    Keywords

    Dividends; Retained earnings; Growth options; Real options; Capital structure; Default; Debt costs;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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