IDEAS home Printed from https://ideas.repec.org/p/ide/wpaper/7179.html
   My bibliography  Save this paper

Free Cash-Flow, Issuance Costs and Stock Price Volatility

Author

Listed:
  • Décamps, Jean-Paul
  • Mariotti, Thomas
  • Rochet, Jean-Charles
  • Villeneuve, Stéphane

Abstract

We study the issuance and payout policies that maximize the value of a firm facing both agency costs of free cash-flow and external financing costs. We find that the firm optimally issues equity. Equity distributes no dividends until a target cash level is reached, while new equity is issued when the firm runs out of cash. We characterize the process modelling the number of outstanding shares and the dynamics of the stock prices. In line with the leverage effect identified by Black (1976), we show that both the volatility of stock returns and the dollar volatility of stock prices increase after a negative shock on stock prices.

Suggested Citation

  • Décamps, Jean-Paul & Mariotti, Thomas & Rochet, Jean-Charles & Villeneuve, Stéphane, 2008. "Free Cash-Flow, Issuance Costs and Stock Price Volatility," IDEI Working Papers 518, Institut d'Économie Industrielle (IDEI), Toulouse.
  • Handle: RePEc:ide:wpaper:7179
    as

    Download full text from publisher

    File URL: http://idei.fr/sites/default/files/medias/doc/wp/2008/cash_flow.pdf
    File Function: Full text
    Download Restriction: no

    References listed on IDEAS

    as
    1. Harald Hau, 2006. "The Role of Transaction Costs for Financial Volatility: Evidence from the Paris Bourse," Journal of the European Economic Association, MIT Press, vol. 4(4), pages 862-890, June.
    2. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    4. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    5. Altinkilic, Oya & Hansen, Robert S, 2000. "Are There Economies of Scale in Underwriting Fees? Evidence of Rising External Financing Costs," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 191-218.
    6. Lee Pinkowitz & René Stulz & Rohan Williamson, 2006. "Does the Contribution of Corporate Cash Holdings and Dividends to Firm Value Depend on Governance? A Cross-country Analysis," Journal of Finance, American Finance Association, vol. 61(6), pages 2725-2751, December.
    7. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    8. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, August.
    9. Christie, Andrew A., 1982. "The stochastic behavior of common stock variances : Value, leverage and interest rate effects," Journal of Financial Economics, Elsevier, vol. 10(4), pages 407-432, December.
    10. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    11. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    12. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    13. Bruno Biais & Thomas Mariotti & Guillaume Plantin & Jean-Charles Rochet, 2007. "Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 345-390.
    14. Michael Faulkender & Rong Wang, 2006. "Corporate Financial Policy and the Value of Cash," Journal of Finance, American Finance Association, vol. 61(4), pages 1957-1990, August.
    15. ., 2007. "Current Controversies in Law and Corporate Finance," Chapters,in: Law and Corporate Finance, chapter 6 Edward Elgar Publishing.
    16. DeAngelo, Harry & DeAngelo, Linda & Stulz, Rene M., 2006. "Dividend policy and the earned/contributed capital mix: a test of the life-cycle theory," Journal of Financial Economics, Elsevier, vol. 81(2), pages 227-254, August.
    17. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
    18. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 2000. "Agency Problems and Dividend Policies around the World," Journal of Finance, American Finance Association, vol. 55(1), pages 1-33, February.
    19. Radner, Roy & Shepp, Larry, 1996. "Risk vs. profit potential: A model for corporate strategy," Journal of Economic Dynamics and Control, Elsevier, vol. 20(8), pages 1373-1393, August.
    20. Heitor Almeida & Murillo Campello & Michael S. Weisbach, 2004. "The Cash Flow Sensitivity of Cash," Journal of Finance, American Finance Association, vol. 59(4), pages 1777-1804, August.
    21. ., 2007. "The Role of Law in Corporate Finance," Chapters,in: Law and Corporate Finance, chapter 1 Edward Elgar Publishing.
    22. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    23. Easterbrook, Frank H, 1984. "Two Agency-Cost Explanations of Dividends," American Economic Review, American Economic Association, vol. 74(4), pages 650-659, September.
    24. ., 2007. "Empirical Analysis of the Law and Corporate Finance," Chapters,in: Law and Corporate Finance, chapter 5 Edward Elgar Publishing.
    25. Ivalina Kalcheva & Karl V. Lins, 2007. "International Evidence on Cash Holdings and Expected Managerial Agency Problems," Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1087-1112.
    26. Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
    27. Kim, Chang-Soo & Mauer, David C. & Sherman, Ann E., 1998. "The Determinants of Corporate Liquidity: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(03), pages 335-359, September.
    28. Dittmar, Amy & Mahrt-Smith, Jan, 2007. "Corporate governance and the value of cash holdings," Journal of Financial Economics, Elsevier, vol. 83(3), pages 599-634, March.
    29. repec:hrv:faseco:30747163 is not listed on IDEAS
    30. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    31. ., 2007. "History of Law and Corporate Finance," Chapters,in: Law and Corporate Finance, chapter 4 Edward Elgar Publishing.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:dau:papers:123456789/12476 is not listed on IDEAS
    2. Gryglewicz, Sebastian, 2011. "A theory of corporate financial decisions with liquidity and solvency concerns," Journal of Financial Economics, Elsevier, vol. 99(2), pages 365-384, February.
    3. Léautier, Thomas-Olivier & Rochet, Jean-Charles, 2014. "On the strategic value of risk management," International Journal of Industrial Organization, Elsevier, vol. 37(C), pages 153-169.
    4. Flavia Barsotti, 2012. "Optimal Capital Structure with Endogenous Default and Volatility Risk," Working Papers - Mathematical Economics 2012-02, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    5. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
    6. Rochet, Jean-Charles & Villeneuve, Stéphane, 2011. "Liquidity management and corporate demand for hedging and insurance," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 303-323, July.
    7. Akyildirim, Erdinç & Güney, I. Ethem & Rochet, Jean-Charles & Soner, H. Mete, 2014. "Optimal dividend policy with random interest rates," Journal of Mathematical Economics, Elsevier, vol. 51(C), pages 93-101.
    8. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ide:wpaper:7179. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/idtlsfr.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.