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Corporate growth and strategic payout policy

Abstract

This study investigates the role of corporate growth in corporate payout policies. We define a good signaling firm as a high-growth firm paying dividends. We find that good signaling firms have better future operating performances, indicating that high-growth firms pay dividends for the purpose of signaling rather than reducing the problem of free cash flow. In addition, the market efficiently gives price appreciation to good signaling firms around the dividend announcement dates. We also report that high-growth firms can utilize dividend payments to reduce information asymmetry between firms and investors and obtain new funds at lower costs. However, if market uncertainty is high, the benefit of good signaling may be offset by the increase in the cost of equity. High-growth firms thus tend to pay lower dividends if they face higher systematic risk or downturn probability.

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Notes

  1. Please see Sect. 2 for a detailed discussion of signaling, free cash flow, and financial flexibility hypotheses.

  2. The dividend policy from low-growth firms paying dividends is still mixed because of the unobserved optimal dividend payout ratios of firms.

  3. High-growth firms may face the free cash flow problem in some special cases. For example, a structural change in corporate governance of a high-growth firm aggravates the issue of the free cash flow problem.

  4. Meza et al. (2020) document a similar argument from the investigation of the corporate life cycle.

  5. Choi et al. (2011) implicitly show that the dividend policies of low-growth firms are more related to their earnings prospects than those of high-growth firms.

  6. Studies by Nissim and Ziv (2001), Brook et al. (1998), Bernheim and Wantz (1995), Kao and Wu (1994), and Healy and Palepu (1988) support the signaling (asymmetric information) hypothesis, finding a positive association between dividend increases and future profitability. In contrast, the studies of Benartzi et al. (1997) and DeAngelo et al. (1996) provide no support for the hypothesized relationship between dividend changes and future profitability.

  7. Lee et al. (2011) also discuss how the risk affects the payout policies of high-growth and low-growth firms. However, the hypothesis in Lee et al. (2011) is based on the theoretical model, with arguments of financial flexibility and the free cash flow hypothesis. In this study, Hypothesis 4is based on the tradeoff between the signaling effect and the cost of proceeds.

  8. The cost of equity is calculated from the beta coefficient and the capital asset pricing model based on monthly returns. Therefore, the cost of equity is on a monthly basis.

  9. We refer to the definition for book equity proposed by Kayhan and Titman (2007), and obtain the market equity by the product of stock price and the number of shares outstanding from CRSP.

  10. We introduce firm size as an independent variable in the regression to control for the size effect on the dividend policy.

  11. For robustness, we use a high-growth dummy to examine whether high-growth firms paying dividends are good signaling firms. Consistent results in Table 11 in Appendix show that the interaction term between the dividends variable and the high-growth dummy is significant and positive.

  12. We define high-growth (low-growth) firms as firms with corresponding book-to-market ratios among the top (bottom) 20% of all sample firms in each year. We then include dividend-paying firms or dividend-increase firms for each growth group. Therefore, different numbers of firm years across subsets will be observed in Table 5.

  13. For robustness, we use a high-growth dummy to examine whether high-growth firms paying dividends can obtain lower costs of equity in the future. Appendix Table 12, shows consistent results supporting the third hypothesis.

  14. VIX index is obtained from the website of Cboe Global Markets, Inc. and not available until 1990.

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Acknowledgements

Hong-Yi Chen gratefully acknowledges financial support from National Science Council in Taiwan for awarding the Grant 105-2410-H-004-084.

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Correspondence to Fang-Chi Lin.

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Appendix

Appendix

See Tables 10, 11 and 12.

Table 10 The impact of good signaling on five-year changes in profitability
Table 11 The impact of good signaling on five-year average profitability
Table 12 The impact of good signaling on five-year average of the cost of equity

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Chen, BS., Chen, HY., Chen, HY. et al. Corporate growth and strategic payout policy. Rev Quant Finan Acc (2022). https://doi.org/10.1007/s11156-022-01053-z

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Keywords

  • Dividend
  • Corporate growth
  • Payout policy
  • Signaling hypothesis
  • Cost of equity

JEL Classification

  • C10
  • G35