Optimal payout ratio under uncertainty and the flexibility hypothesis: Theory and empirical evidence

Abstract

We theoretically extend the proposition of DeAngelo and DeAngelo′s (Journal of Financial Economics 79, 293–315, 2006) optimal payout policy in terms of the flexibility dividend hypothesis. We also introduce growth rate, systematic risk, and total risk variables into the theoretical model. Our empirical findings show that based on flexibility considerations, a company will reduce its payout when the growth rate increases. In addition, 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. We use a panel data collected in the USA from 1969 to 2009 to empirically investigate the impact of growth rate, systematic risk, and total risk on the optimal payout ratio in terms of the fixed-effects model. Furthermore, we implement the moving estimates process to find the empirical breakpoint of the structural change for the relationship between the payout ratio and risks and confirm that the empirical breakpoint is not different from our theoretical breakpoint. Our theoreticalmodel 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.