Payout Policy and Real Investment under Asymmetric Information

Yordying Thanatawee

Abstract


This paper develops a theoretical model explaining management’s choice of using corporate cash flow to pay dividends, repurchase shares, or invest in a real project.The model demonstrates the case in which managers have better information than investors about the quality of the firm (information asymmetry) and may invest excess cash in unprofitable projects rather than return it to shareholders (moral hazard). The results show that paying dividends is a dominated strategy for the high-quality firm.In an efficient market, there exists a separating equilibrium in which the high-quality firm invests in the new project while the low-quality firm pays dividends. However, ifinvestors underreact to share repurchase announcements, there exists a separating equilibrium in which the high-quality firm repurchases shares while the low-quality firm pays dividends.


Full Text: PDF DOI: 10.5539/ijef.v3n5p250

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International Journal of Economics and Finance  ISSN  1916-971X (Print) ISSN  1916-9728 (Online)

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