Dividend policy, systematic liquidity risk, and the cost of equity capital

• Published in: Review of quantitative finance and accounting Vol. 60; no. 3; pp. 839 - 876
• Main Authors: Mazouz, Khelifa, Wu, Yuliang, Ebrahim, Rabab, Sharma, Abhijit
• Format: Journal Article
• Language: English
• Published: New York Springer US 01.04.2023; Springer Nature B.V
• Subjects: Accounting/Auditing; Asymmetry; Cash flow; Companies; Corporate Finance; Dividend policy; Econometrics; Economic conditions; Economic crisis; Economics and Finance; Equity capital; Finance; Hypotheses; Investments; Liquidity; Operations Research/Decision Theory; Original Research; Payments; Risk exposure; Risk reduction; Stock exchanges; Stockholders; Value; Dividend policy; Firm value; G32; G35; G12; Systematic liquidity risk; Cost of equity capital
• ISSN: 0924-865X; 1573-7179
• DOI: 10.1007/s11156-022-01114-3

This paper examines a new channel through which dividend policy can affect firm value. We find that firms that pay dividends exhibit lower systematic liquidity risk than those that do not. We also report a significant negative relationship between dividend payment and systematic liquidity risk. The liquidity improvement associated with dividend payments translates into an economically meaningful reduction in the cost of equity capital. Our results are robust to endogeneity concerns, to alternative measures of liquidity risk and dividend payouts, and to alternative model specifications. Further analysis suggests that the reduction in liquidity risk associated with dividend payouts is more pronounced for weakly governed firms and firms with opaque informational environment. Finally, we find that the recent financial crisis led to a greater increase in systematic liquidity risk for firms with no or low dividend payouts. Overall, our study implies that dividend policy can be used by corporate managers to shape liquidity risk and mitigate the adverse impact of economic downturns on the value of their firms.