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Optimal Payout Ratio under Uncertainty and the Flexibility Hypothesis: Theory and Empirical Evidence

In: Encyclopedia of Finance

Author

Listed:
  • Cheng-Few Lee

    (Rutgers University)

  • Manak C. Gupta

    (Temple University)

  • Hong-Yi Chen

    (Department of Finance, National Chengchi University)

  • Alice C. Lee

    (Center for PBBEF Research)

Abstract

Following the dividend flexibility hypothesis used by DeAngelo and DeAngelo (J Financ Econ 81, 227–254, 2006), Blau and Fuller (J Corp Financ 14:133–152, 2008), and others, we theoretically extend the proposition of DeAngelo and DeAngelo’s (J Financ Econ 81, 227–254, 2006) optimal payout policy in terms of the flexibility dividend hypothesis. We also introduce growth rate, systematic risk, and total risk variables into the theoretical model. In addition, based upon Lee and Lee (2021), we discuss the implication of the existence of optimal payout ratio in financial analysis and decision for a company. To test the theoretical results derived in this chapter, we use data collected in the USA from 1969 to 2009 to investigate the impact of growth rate, systematic risk, and total risk on the optimal payout ratio in terms of the fixed-effect model. We find that based on flexibility considerations, a company will reduce its payout when the growth rate increases. In addition, we find that a nonlinear relationship exists between the payout ratio and the risk. In other words, the relationship between the payout ratio and risk is negative (or positive) when the growth rate is higher (or lower) than the rate of return on total assets. Our theoretical model and empirical results can therefore be used to identify whether flexibility or the free cash flow hypothesis should be used to determine the dividend policy.

Suggested Citation

  • Cheng-Few Lee & Manak C. Gupta & Hong-Yi Chen & Alice C. Lee, 2022. "Optimal Payout Ratio under Uncertainty and the Flexibility Hypothesis: Theory and Empirical Evidence," Springer Books, in: Cheng-Few Lee & Alice C. Lee (ed.), Encyclopedia of Finance, edition 0, chapter 101, pages 2409-2455, Springer.
    • Handle: RePEc:spr:sprchp:978-3-030-91231-4_104
    DOI: 10.1007/978-3-030-91231-4_104
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