Abstract
When shareholders have different plans to sell their shares, they will, in general, have different preferences concerning the firm's decision to pay out cash using dividends or share repurchase. We illustrate these different preferences and explore a model of payout policy that highlights the adverse selection costs of repurchases when managers have superior information about the value of the firm. We show that, in the absence of fixed costs to repurchasing shares, there is a separating equilibrium in which managers use taxable dividends to signal the quality of the firm, with better firms paying lower dividends, using repurchases for the remainder of the payout. With fixed costs to repurchasing, small payouts are made via dividend and large payouts are divided between repurchases and dividends, as in the no-fixed cost case. In both cases, the percentage of shares repurchased increases with the size of the payout and larger repurchases are better news.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 233-253 |
| Number of pages | 21 |
| Journal | Journal of Financial and Quantitative Analysis |
| Volume | 33 |
| Issue number | 2 |
| DOIs | |
| State | Published - Jun 1 1998 |
Funding
Lucas, Northwestern University and NBER; McDonald, Northwestern University, J. L. Kellogg Graduate School of Management, Department of Finance, Leverone Hall, Evanson, IL 60208. The authors thank Robert Heinkel (associate editor and referee), V. Maksimovic, Burton Hollifield, Kose John, Joe Williams, and seminar participants at the University of British Columbia, the University of Florida, Michigan State University, and New York University for useful comments. Financial support from the Bradley Foundation is gratefully acknowledged.
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics