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

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  • YANN BRAOUEZEC

    (ESILV- Dept Ingénierie Financière, 92916 Paris La Défense Cedex, France)

  • CHARLES-ALBERT LEHALLE

    (Crédit Agricole Cheuvreux, Calyon Group, 92920 Paris La Défense Cedex, France)

Abstract

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).

Suggested Citation

  • Yann Braouezec & Charles-Albert Lehalle, 2010. "Corporate Liquidity, Dividend Policy And Default Risk: Optimal Financial Policy And Agency Costs," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(04), pages 537-576.
    • Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:04:n:s0219024910005929
    DOI: 10.1142/S0219024910005929
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    References listed on IDEAS

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    1. Ronald C. Lease, & Kose John, & Avner Kalay, & Uri Loewenstein, & Oded H. Sarig,, 1999. "Dividend Policy:: Its Impact on Firm Value," OUP Catalogue, Oxford University Press, number 9780875844978, Decembrie.
    2. Anderson, Ronald & Carverhill, Andrew, 2005. "A Model of Corporate Liquidity," CEPR Discussion Papers 4994, C.E.P.R. Discussion Papers.
    3. Rochet, Jean Charles & Villeneuve, Stéphane, 2004. "Liquidity Risk and Corporate Demand for Hedging and Insurance," CEPR Discussion Papers 4755, C.E.P.R. Discussion Papers.
    4. Anderson, Ronald W. & Carverhill, Andrew, 2005. "A model of corporate liquidity," LSE Research Online Documents on Economics 24643, London School of Economics and Political Science, LSE Library.
    5. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
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