Corporate Payout Policy, Cash Savings, and the Cost of Consistency: Evidence from a Structural Estimation

Authors

  • Hamed Mahmudi,

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    • Hamed Mahmudi is an Assistant Professor in the Price College of Business at the University of Oklahoma in Norman, OK. Michael Pavlin is an Assistant Professor in the School of Business and Economics at Wilfrid Laurier University in Waterloo, ON, Canada.

  • Michael Pavlin

    Search for more papers by this author
    • Hamed Mahmudi is an Assistant Professor in the Price College of Business at the University of Oklahoma in Norman, OK. Michael Pavlin is an Assistant Professor in the School of Business and Economics at Wilfrid Laurier University in Waterloo, ON, Canada.


  • This paper benefited extensively from discussions with Jan Mahrt-Smith, Craig Doidge, Raymond Kan, Sergei Davydenko, Alexander Dyck, and Marcel Rindisbacher. We are also grateful for suggestions from Bill Christie (Editor) and an anonymous referee that have greatly improved the paper. We would like to thank the Rotman Finance Lab for providing computational facilities that made this study possible while we were at the University of Toronto. All errors are the authors’ responsibility. This paper was previously circulated under the title “What Drives Corporate Excess Cash? Evidence from a Structural Estimation.”

Abstract

We develop a dynamic structural model to better understand how corporate payout policy is determined in conjunction with other corporate decisions. In a first-best model, a manager maximizes equity value by choosing the firm's optimal financing, investment, dividends, and cash holdings. By using simulated method of moments, we show that, on average, firms excessively smooth their payout while making corporate savings overly volatile and retaining excess cash. We then extend the model to capture the effect of a manager, who perceives a cost to cutting payouts. Estimating the model, we infer the magnitude of this cost. We find that a managerial preference for consistent payout explains the smooth payout and high volatility of cash holdings.

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