The Effect of Financial Flexibility on Payout Policy

Anil Kumar and Carles Vergara-Alert

We use variation in real estate prices as exogenous shocks to firms’ debt capacity to study the causal effect of financial flexibility on payout policy. We show that an increase in financial flexibility results in higher dividends, share repurchases, and payout flexibility. We find that a one-standard-deviation increase in the firms’ collateral value results into a 0.26 and 0.55 percentage points increase in non-discretionary payout and discretionary payout, respectively. This effect is stronger for firms with few investment opportunities. Moreover, highly leveraged firms are more likely to cut dividends in response to a sharp decrease in their financial flexibility.