DP16199 Do capital structure models square with the dynamics of payout?

Author(s): Shiqi Chen, Bart Lambrecht
Publication Date: May 2021
Keyword(s): Capital Structure, leverage target, payout smoothing, pecking order model
JEL(s): G11, G32, G35
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16199

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.