The article at a glance: Kevin Schneider shows how firms’ optimal payout policies line up with their investment policies. Thus, real frictions, not financial frictions, play a large role in explaining distributions to shareholders. The research offers a new angle to corporate finance and asset pricing research.

Production-Based Payout Policies

By Kevin Schneider, CERF/CCFin Research Associate, Cambridge Judge Business School, University of Cambridge

What we already know and what we overlooked

Why do companies pay dividends to their shareholders? This age-old question in corporate finance has plenty of answers: Agency conflicts, financial frictions, and asymmetric information are but a few examples (including the works of CERF’s very own Bart Lambrecht and Shiqi Chen).[1]

Evidence from the field draws a clear picture, though: In his survey of CFOs, Graham (2022) reports that investment decisions are a more important driver of corporate payout policies than financial concerns such as debt repayments or cash management. This is not surprising: Decomposing firms’ cash flows into operating activities, investing activities, financing activities (changes in debt and cash), and total equity distributions (cash dividends and share repurchases), Panel A of Figure 1 illustrates that investments (red line) are of a much larger magnitude than financing cash flows (green line). Investment policies, not financing policies, are the first-order choice variables of firm managers. Panel B of Figure 1 corrects the investment cash flows to also account for investments into intangible capital (e.g., knowledge capital or organization capital) which are otherwise deducted from the operating cash flows as R&D and SG&A expenses. In this case, total investments are an even more important concern for corporate treasurers.

Surprising, however, is why investment-based theories have gathered so little attention in determining payout policies. In an influential review paper, DeAngelo et al. (2008) do not even mention real frictions such as “capital adjustment costs” or “Tobin’s Q”. The exception are highly sophisticated neoclassical models that typically require simulations to shed light on their quantitative predictions and propose difficult-to-test channels (often relying on financial frictions such as cash accumulation).[2] In our paper, we develop a transparent q-theory model of firm investment with closed-form solutions that can be directly estimated with data. We find that standard investment frictions go a long way in matching payout policies, thereby providing a supply-based explanation for payouts. We support our model predictions using reduced-form evidence (via panel regressions) and structural estimations (via GMM).

Choosing the right measure: Intangible capital and total payout yield

To be specific, we develop a q-theory model in which firms choose investments in physical and intangible capital subject to symmetric adjustment costs to maximise their equity value. Payouts are the residual of optimal investment and financing policies. Importantly, the model focusses on real frictions and includes no financial constraints, cash enters at most as “negative debt”, and the Modigliani-Miller theorems about the irrelevance of leverage and payout policies apply. The key driver in the model are capital adjustment costs that determine the investment opportunity sets and marginal q’s of physical capital and intangible capital.

We find that our model of corporate investment matches average stock returns and average payout yields well. Two important insights emerge from our study: Accounting for firms’ total investment and total payout is important: Focussing only on physical capital investment (“capex”) neglects a large part of firms’ real activity (intangible capital in patents, brands, and organization capital). Focussing only on cash dividends neglects a large part of firms’ distributions to shareholders (via share repurchases and issuances).

Learning Asset Pricing from Corporate Finance

Beyond corporate finance, our findings are important for asset pricing research. By decomposing the total stock return in capital gain and dividend yield, we can test if the investment-based model also prices these two underlying (and thus far overlooked) moment conditions. Our positive results lend further empirical support for the economics underlying investment-based asset pricing. Importantly, investment-based theories make testable predictions for dividend yields resulting from optimal firm policies whereas consumption-based models take dividend dynamics as exogeneous and cannot speak to this aspect of the cross-section of stock returns.

[1] See Lambrecht and Myers (2012, 2017) and Chen and Lambrecht (2021).

[2] See Hennessy et al. (2007), Bolton et al. (2011), DeMarzo et al. (2012), Begenau and Salomao (2019), Bolton et al. (2019), and Abel and Panageas (2022).

References

Abel, Andrew B. and Stavros Panageas, 2022, An analytic framework for interpreting investment regressions in the presence of financial constraints, Review of Financial Studies 35, 4055–4104.

Alfaro, Iván, Alessandro Graniero, and Kevin Schneider, 2025, Production-Based Payout Policies, SSRN Working paper 4986997.

Begenau, Juliane and Juliana Salomao, 2019, Firm financing over the business cycle, Review of Financial Studies 32, 1235–1274.

Bolton, Patrick, Hui Chen and Neng Wang, 2011, A unified theory of Tobin’s q, corporate investment, financing, and risk management, Journal of Finance 66, 1545–1578.

Bolton, Patrick, Neng Wang and Jinqiang Yang, 2019, Investment under uncertainty with financial constraints, Journal of Economic Theory 184, 104912.

Chen, Shiqi and Bart M. Lambrecht, 2021, Do Capital Structure Models Square with the Dynamics of Payout?, Annual Review of Financial Economics 13, 271–299.

DeAngelo, Harry, Linda DeAngelo and Douglas J. Skinner, 2008, Corporate Payout Policy, Foundations and Trends in Finance 3, 95–287.

DeMarzo, Peter M., Michael J. Fishman, Zhiguo He and Neng Wang, 2012, Dynamic agency and the q theory of investment, Journal of Finance 67, 2295–2340.

Graham, John R., 2022, Presidential address: Corporate finance and reality, Journal of Finance 77, 1975–2049.

Hennessy, Christopher A., Amnon Levy, and Toni M. Whited, 2007, Testing Q theory with financing frictions, Journal of Financial Economics 83, 691–717.

Lambrecht, Bart M. and Stewart C. Myers, 2012, A Lintner Model of Payout and Managerial Rents, Journal of Finance 67, 1761–1810.

Lambrecht, Bart M. and Stewart C. Myers, 2017, The Dynamics of Investment, Payout and Debt, Review of Financial Economics 30, 3759–3800.