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12 May 2015Working Paper Summaries

Financing Payouts

by Joan Farre-Mensa, Roni Michaely and Martin C. Schmalz
This paper is the first to systematically study the extent to which industrial public firms in the US rely on the proceeds of security issues to fund payouts. By simultaneously raising and paying out capital, firms can accomplish a number of objectives, such as jointly managing their capital structure and cash holdings, monitoring managers' investment decisions, engaging in market timing, or increasing earnings-per-share. These results paint a very different picture from the commonly held view that payouts are first and foremost a vehicle to return free cash flow to investors. Key concepts include:
  • A third of aggregate payouts is not funded by internally generated funds but rather is financed in the capital markets via net debt or equity issues. Conversely, a staggering 34 percent of the capital firms raise in the capital markets is paid out by the same firms during the same year.
  • The pervasiveness, economic magnitude, and persistence of financed payouts suggest that the benefits associated with this behavior are more important than it has been recognized by prior work. At the same time, the external financing costs associated with financed payouts may be less important than it is assumed in the literature.
  • Firms' payout and issuance decisions are intrinsically related. Much can be gained by studying them jointly as interdependent elements of the financial ecosystem.

Author Abstract

The established conventional wisdom is that payouts are first and foremost a vehicle to return free cash flow to investors. In stark contrast, we find that 32% of aggregate payouts are simultaneously raised in the capital markets by the same firms, mainly through debt but also through equity. Conversely, issuers pay out 39% of the aggregate proceeds of net debt issues and 19% of the proceeds of firm-initiated equity issues during the same year. Over 42% of payout payers engage in such "payout financing" behavior, which is widespread among both dividend-paying and repurchasing firms. The frequency, magnitude, and persistence of financed payouts are unexpected, particularly in light of the obvious costs associated with this behavior. Cross-sectional analyses suggest that firms use financed payouts to manage their capital structure, monitor managers, engage in market timing, and boost earnings-per-share.

Paper Information

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