CORPORATE LIQUIDITY, DIVIDEND POLICY AND DEFAULT RISK: OPTIMAL FINANCIAL POLICY AND AGENCY COSTS

Yann Braouezec () and Charles-Albert Lehalle
Additional contact information
Yann Braouezec: ESILV- Dept Ingénierie Financière, 92916 Paris La Défense Cedex, France

International Journal of Theoretical and Applied Finance (IJTAF), 2010, vol. 13, issue 04, 537-576

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).

Keywords: Corporate liquidity; dividend policy; Modigliani-Miller theorem; default risk; stochastic default thresholds; agency cost of dividend policy (search for similar items in EconPapers)
Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024910005929
Access to full text is restricted to subscribers

Related works:
Working Paper: Corporate Liquidity, Dividend Policy and Default Risk: Optimal Financial Policy and Agency Costs (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:13:y:2010:i:04:n:s0219024910005929

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024910005929

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().