Dynamic Optimal Risk Management and Dividend Policy under Optimal Capital Structure and Maturity
This paper examines the interaction between a firm's volatility and dividend policies and capital structure and maturity policies. The firm is permitted to costlessly and continuously select any asset volatility and dividend yield, within bounds. Simple and intuitive rules are derived for the firm's optimal dividend and volatility choices. It is found that the firm always optimally selects either the maximal or minimal dividend yield and asset volatility and that these decisions depend, respectively, only upon the delta and gamma of the firm's equity. These optimal dividend and volatility policies are then implemented within the context of the Leland and Toft (1996) capital structure model. It is found that firms will optimally select a low dividend yield and a low asset volatility over a greater range of firm asset values the shorter is the maturity of the firm's debt. Anticipating this behavior, bondholders will demand a smaller credit spread for short-term debt when the firm has great leeway in choosing its asset volatility. In turn, this may induce a firm to optimally issue short-term debt. It is also found that the better is a firm's ability to hedge, the more frequently it will refrain from paying dividends. This confirms the well-known result that risk management mitigates incentives for underinvestment. Here it is shown to apply ex-post as well as ex-ante.
|Date of creation:||01 Jul 1998|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://haas.berkeley.edu/finance/WP/rpflist.html
More information through EDIRC
|Order Information:|| Postal: IBER, F502 Haas Building, University of California at Berkeley, Berkeley CA 94720-1922|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
- Diamond, Douglas W, 1989.
"Reputation Acquisition in Debt Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 97(4), pages 828-62, August.
- Long, Michael S. & Malitz, Ileen B. & Sefcik, Stephan E., 1994. "An Empirical Examination of Dividend Policy Following Debt Issues," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(01), pages 131-144, March.
- Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
- Hayne E. Leland and Klaus Bjerre Toft., 1995.
"Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads,"
Research Program in Finance Working Papers
RPF-259, University of California at Berkeley.
- Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
- Barclay, Michael J & Smith, Clifford W, Jr, 1995. " The Priority Structure of Corporate Liabilities," Journal of Finance, American Finance Association, vol. 50(3), pages 899-917, July.
- Jong-Il Kim & Lawrence J. Lau, 1996. "The sources of Asian Pacific economic growth," Canadian Journal of Economics, Canadian Economics Association, vol. 29(s1), pages 448-54, April.
- Kane, Alex & Marcus, Alan J. & McDonald, Robert L., 1985.
"Debt Policy and the Rate of Return Premium to Leverage,"
Journal of Financial and Quantitative Analysis,
Cambridge University Press, vol. 20(04), pages 479-499, December.
- Alex Kane & Alan J. Marcus & Robert L. McDonald, 1984. "Debt Policy and the Rate of Return Premium to Leverage," NBER Working Papers 1439, National Bureau of Economic Research, Inc.
- Flannery, Mark J, 1986. " Asymmetric Information and Risky Debt Maturity Choice," Journal of Finance, American Finance Association, vol. 41(1), pages 19-37, March.
- Zwiebel, Jeffrey, 1996. "Dynamic Capital Structure under Managerial Entrenchment," American Economic Review, American Economic Association, vol. 86(5), pages 1197-1215, December.
When requesting a correction, please mention this item's handle: RePEc:ucb:calbrf:rpf-281. 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: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.