Equity Issuance and Divident Policy under Commitment
AbstractThis paper studies a model of corporate finance in which firms use stock issuance to finance investment. Since the firm recognizes the relationship between future dividends and stock prices, future variables enter in the constraints and optimal policy is in general time inconsistent. We discuss the nature of time inconsistency and show that it arises because managers promise to incorporate value maximization gradually into their objective function. This shows how one could change managers’ incentives in order to enforce the optimal contract under full commitment. We then characterize several cases where time consistency arises and we study different examples where policy is time inconsistent. This allows us to address some outstanding issues in the literature about dividend policy and equity issuance. In particular, our results suggest that growing firms that can credibly commit will pay lower dividends at the beginning and promise higher dividends in the future, consistent with empirical evidence. Our results also suggests that compensation that is tied to stock options creates incentives to inflate prices and pay lower dividends. This is consistent with the empirical evidence of increased stock option compensation and payout through repurchases instead to dividends during the last decades.
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Bibliographic InfoPaper provided by Stony Brook University, Department of Economics in its series Department of Economics Working Papers with number 10-07.
Date of creation: Dec 2010
Date of revision:
Stock Issuance; time inconsistency; dividend policy;
Find related papers by JEL classification:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-02-12 (All new papers)
- NEP-MAC-2011-02-12 (Macroeconomics)
- NEP-MIC-2011-02-12 (Microeconomics)
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