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Optimal payout ratio under uncertainty and the flexibility hypothesis: Theory and empirical evidence

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  • Lee, Cheng-Few
  • Gupta, Manak C.
  • Chen, Hong-Yi
  • Lee, Alice C.

Abstract

Following the dividend flexibility hypothesis used by DeAngelo and DeAngelo (2006), Blau and Fuller (2008), and others, we theoretically extend the proposition of DeAngelo and DeAngelo (2006) optimal payout policy in terms of the flexibility dividend hypothesis. In addition, we also introduce growth rate, systematic risk, and total risk variables into the theoretical model. To test the theoretical results derived in this paper, we use the data collected in the US from 1969 to 2009 to investigate the impact of the 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 the 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

  • Lee, Cheng-Few & Gupta, Manak C. & Chen, Hong-Yi & Lee, Alice C., 2011. "Optimal payout ratio under uncertainty and the flexibility hypothesis: Theory and empirical evidence," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 483-501, June.
  • Handle: RePEc:eee:corfin:v:17:y:2011:i:3:p:483-501
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    Cited by:

    1. repec:kap:rqfnac:v:50:y:2018:i:2:d:10.1007_s11156-017-0640-2 is not listed on IDEAS
    2. repec:kap:rqfnac:v:49:y:2017:i:3:d:10.1007_s11156-016-0606-9 is not listed on IDEAS
    3. Ivan E. Brick & Hong-Yi Chen & Chia-Hsun Hsieh & Cheng-Few Lee, 2016. "A comparison of alternative models for estimating firm’s growth rate," Review of Quantitative Finance and Accounting, Springer, vol. 47(2), pages 369-393, August.
    4. Chen, Hong-Yi & Gupta, Manak C. & Lee, Alice C. & Lee, Cheng-Few, 2013. "Sustainable growth rate, optimal growth rate, and optimal payout ratio: A joint optimization approach," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1205-1222.
    5. Mónika Kuti, 2011. "Cash Flow at Risk, Financial Flexibility and Financing Constraint," Public Finance Quarterly, State Audit Office of Hungary, vol. 56(4), pages 505-517.
    6. Özgür Arslan-Ayaydin & Chris Florackis & Aydin Ozkan, 2014. "Financial flexibility, corporate investment and performance: evidence from financial crises," Review of Quantitative Finance and Accounting, Springer, vol. 42(2), pages 211-250, February.
    7. Stefan Dierkes & Ulrich Schäfer, 2017. "Corporate taxes, capital structure, and valuation: Combining Modigliani/Miller and Miles/Ezzell," Review of Quantitative Finance and Accounting, Springer, vol. 48(2), pages 363-383, February.
    8. Cheng-Few Lee & Woan-lih Liang & Fu-Lai Lin & Yating Yang, 2016. "Applications of simultaneous equations in finance research: methods and empirical results," Review of Quantitative Finance and Accounting, Springer, vol. 47(4), pages 943-971, November.
    9. Pawan Jain & Quentin Chu, 2014. "Dividend clienteles: a global investigation," Review of Quantitative Finance and Accounting, Springer, vol. 42(3), pages 509-534, April.

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