Capital Structure, Payout Policy, and Financial Flexibility

25 Pages Posted: 17 Jul 2006 Last revised: 20 May 2009

See all articles by Harry DeAngelo

Harry DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: October 10, 2007

Abstract

We combine elements of the pecking order and trade-off theories of capital structure to develop a more powerful and empirically descriptive theory in which firms have low long-run leverage targets, debt issuances are temporary deviations from target to meet unanticipated capital needs, firms rebalance to target with a lag despite zero adjustment costs, and mature firms pay substantial dividends to foster access to external equity while limiting internal funds to control agency costs and reduce corporate taxes. The theory generates new testable hypotheses and resolves the main capital structure puzzles including (i) why equity is not "last resort" financing, (ii) why profitable firms pay dividends and maintain low leverage despite the corporate tax benefits of debt, (iii) why firms fail to "lever up" after stock price increases, and (iv) why leverage rebalancing occurs with a lag despite trivial adjustment costs.

Keywords: capital structure, payout policy, dividends, financial flexibility, pecking order, trade-off theory

JEL Classification: G32, G35, G31

Suggested Citation

DeAngelo, Harry and DeAngelo, Linda, Capital Structure, Payout Policy, and Financial Flexibility (October 10, 2007). Marshall School of Business Working Paper No. FBE 02-06. Available at SSRN: https://ssrn.com/abstract=916093 or http://dx.doi.org/10.2139/ssrn.916093

Harry DeAngelo (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-6541 (Phone)
213-740-6650 (Fax)

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-3868 (Phone)
213-740-6650 (Fax)

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