Potential Dividends and Actual Cash Flows: A Regional Latin American Analysis

Abstract

We have examined the value that the market assigns to different components of the cash flow to equity including "potential" dividends. We study non financial publicly traded firms of five Latin American countries: Argentina, Brazil, Chile, Mexico and Peru during the period 1991-2007. The model includes the following variables: market value of equity, dividends paid, change in equity investment and change in liquid assets ("potential" dividends). These variables are regressed with actual equity value (time t) as the dependent variable, and the other variables as independent variables (including equity value) for the next period (time t 1). The applied tests have given robust results.

The main conclusions of this work are three: Firstly, the market assigns less than one dollar to a future dollar for any of the variables studied as expected. Second, in particular, we found that the undistributed "potential" dividends or changes in liquid assets destroy value. I.e. the value of a dollar today in liquid assets in t 1 is negative. Third, we find that, a dollar invested in liquid assets has a negative Net Present Value and it is not a zero NPV investment. These findings confirm the problem of agency costs when not distributing cash flows.

As a practical conclusion, the empirical evidence suggests that we should include, in the working capital, the liquid assets and leave out the practice of adding the book value of liquid assets. The only relevant cash flow is what an investor in fact receives from the equity investment: dividends and stock repurchases.

Keywords: Cash flows, cash flow to equity, free cash flow, liquid assets, potential dividends, firm value, equity value, Modigliani and Miller, levered value, error in valuation

JEL Classification: G12, G15, D82, G35