Sustainable Growth Rate, Optimal Growth Rate, and Optimal Payout Ratio: A Joint Optimization Approach

Journal of Banking and Finance, Vol. 37, No. 4, 2013

61 Pages Posted: 22 Mar 2010 Last revised: 11 Mar 2015

See all articles by Hong-Yi Chen

Hong-Yi Chen

National Chengchi University - Department of Finance

Manak Gupta

Temple University - Department of Finance

Alice C. Lee

State Street Corporate

Cheng-Few Lee

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics

Date Written: October 22, 2012

Abstract

A large number of studies have examined issues of dividend policy, while they rarely consider the investment decision and dividend policy jointly from a non-steady state to a steady state. We extend Higgins’ (1977, 1981, and 2008) sustainable growth rate model and develops a dynamic model which jointly optimizes the growth rate and payout ratio. We optimize the firm value to obtain the optimal growth rate in terms of a logistic equation and find that the steady state growth rate can be used as the benchmark for the mean-reverting process of the optimal growth rate. We also investigate the specification error of the mean and variance of dividend per share when introducing the stochastic growth rate. Empirical results support the mean-reverting process of the growth rate and the importance of covariance between the profitability and the growth rate in determining dividend payout policy. In addition, the intertemporal behavior of the covariance may shed some light on the fact of disappearing dividends over decades.

Keywords: Dividend Policy; Payout Ratio; Growth Rate; Specification Error; Logistic Equation, Partial Adjustment Model, Mean Reverting Process

JEL Classification: C10, G35

Suggested Citation

Chen, Hong-Yi and Gupta, Manak C. and Lee, Alice C. and Lee, Cheng-Few, Sustainable Growth Rate, Optimal Growth Rate, and Optimal Payout Ratio: A Joint Optimization Approach (October 22, 2012). Journal of Banking and Finance, Vol. 37, No. 4, 2013. Available at SSRN: https://ssrn.com/abstract=1571903 or http://dx.doi.org/10.2139/ssrn.1571903

Hong-Yi Chen (Contact Author)

National Chengchi University - Department of Finance ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei, 11623
Taiwan

Manak C. Gupta

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States

Alice C. Lee

State Street Corporate ( email )

1 Lincoln Street
Boston, MA 02111
United States

Cheng-Few Lee

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics ( email )

111 Washington Avenue
Newark, NJ 07102
United States
732-445-3907 (Phone)
732-445-5927 (Fax)

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