Do Capital Structure Models Square with the Dynamics of Payout?
49 Pages Posted: 3 Jun 2021
Date Written: May 26, 2021
We explore whether theoretically the target leverage and pecking order models can be reconciled with payout smoothing. Investment absorbs a significant part of income and asset volatility if the firm follows both a payout target and a net debt ratio (NDR) target. A positive (negative) NDR amplifies (dampens) shocks in assets. Slow adjustment towards the NDR target facilitates payout smoothing. Under strict pecking order financing, income shocks are absorbed primarily by changes in net debt. More payout smoothing implies a stronger negative relation between debt and net income. Shocks to assets in place need not affect current payout.
Keywords: payout smoothing, capital structure, pecking order model, leverage target, investment
JEL Classification: G35, G32, G11
Suggested Citation: Suggested Citation