The Importance of Being Prudent: Dividends, Signaling and Risk Shifting
Simas Kucinskas (VU University Amsterdam)
Shareholders may exploit creditors by engaging in risk shifting. However, shareholders with favorable private information have an incentive to convey it to outside parties to avoid mispricing. I show that not engaging in risk shifting—”being prudent”—can be a credible signal of unobserved firm quality. Empirically, the model predicts that higher quality firms pay lower dividends and invest in safer projects when franchise values are low. Normatively, signaling may raise welfare if risk shifting is socially costly. The results are useful for understanding aspects of bank dividend policy in 2007-8.
The (Self-)Funding of Intangibles
Robin Döttling (University of Amsterdam)
In response to technological change, U.S. corporations have been investing more in intangible capital. This transformation is empirically associated with lower leverage and greater cash holdings, and commonly explained as a precautionary response to reduced debt capacity. We model how firms’ payout and cash holding policies are affected by this shift. Our insight is that the creation of intangibles is largely achieved by human capital investment and requires lower upfront outlays. Firms can self-finance the retention of human capital by granting deferred equity compensation. Interestingly, retaining cash and repurchasing shares enhances the value of unvested equity, thereby facilitating retention and reducing equity dilution. Our empirical evidence confirms that firms with higher intangible investment have lower upfront investment needs. They make similar payouts as tangible investment firms, suggesting they are not on average more financially constrained. They also tend to grant more deferred equity and prioritize repurchases over dividends in particular when their stock volatility is high, in line with our model’s predictions. Joint with Tomislav Ladika and Enrico Perotti.