Optimal Payout Ratio Under Uncertainty and the Flexibility Hypothesis: Theory and Empirical Evidence

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

Chapter 96 in Handbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning:(In 4 Volumes), 2020, pp 3367-3412 from World Scientific Publishing Co. Pte. Ltd.

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’s (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 data collected in the US from 1969 to 2009 to investigate the impact of 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 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.

Keywords: Financial Econometrics; Financial Mathematics; Financial Statistics; Financial Technology; Machine Learning; Covariance Regression; Cluster Effect; Option Bound; Dynamic Capital Budgeting; Big Data (search for similar items in EconPapers)
JEL-codes: C01 C1 G32 (search for similar items in EconPapers)
Date: 2020
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Journal Article: Optimal payout ratio under uncertainty and the flexibility hypothesis: Theory and empirical evidence (2011)
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