Internal Capital Market Inefficiencies, Shareholder Payout, and Abnormal Leverage

Abstract

This study examines internal capital market inefficiencies and U.S. multinational firms’ return of capital to shareholders. Using dividends and repurchases to measure the return of capital, we first document a difference in the relations between shareholder payouts and cash held either domestically or by foreign subsidiaries. This suggests that internal capital market inefficiencies related to foreign cash constrain shareholder payouts in addition to other consequences previously documented in the literature such as domestic underinvestment and foreign overinvestment. In cross-sectional analysis, we show the relation between foreign cash and total payout is positive for firms with less costly access to external capital, which is consistent with the notion that external financing enables shareholder payouts despite internal capital market inefficiencies. Finally, we investigate if firms subject to internal capital market inefficiencies borrow to satisfy shareholder payout demands. The evidence suggests that a potential negative consequence of foreign cash is that weak financial-health firms exhibit a positive association between abnormal leverage and shareholder payouts.

Keywords: Internal Capital Market, Foreign Cash, Dividend, Repurchase, Payout Policy, Abnormal Leverage

JEL Classification: F23, G35, H25