Corporate finance.

• Author: Rajan, Raghuram G.
• Position: Program Report

The NBER's Program on Corporate Finance has a strong and dedicated core group and, in its brief existence (since 1991), has initiated some very promising avenues of research. Narrowly interpreted, corporate finance is the study of the investment and financing policies of corporations. But, since firms are at the center of economic activity, and because almost any topic of concern to economists--from microeconomic issues like incentives and risk sharing to macroeconomic issues such as currency crises--affects corporate financing and investment, it is increasingly hard to draw precise boundaries around the field.

The range of subjects that group members have addressed in their research also reflects this difficulty, in fact, some of the most interesting work in corporate finance now is being done at its interface with other areas. Here I have chosen a set of our papers, because there are far too many for me to describe all of them, that fall into fairly coherent subject areas. The order in which I describe the subjects loosely follows from micro to macro: dividend policy to international finance.

Dividend Policy

Given that the study of dividend policy is as old as the modern field of finance (recall the Miller-Modigliani work on dividends), it might seem surprising that there is something left to say about it. Yet, although the questions remain the same, we have new- hypotheses and new or better evidence on old ones.

Brav et al. (W9657) survey Chief Financial Officers and Treasurers of companies to determine key factors driving dividend policy. They find the traditional behavioral patterns: managers are reluctant to cut dividends, prefer to smooth dividends over time, and tie dividend increases to long-run sustainable earnings. But they are also more willing to use stock repurchases nowadays. The authors also conclude that managers give only moderate weight to traditional tax, agency, and clientele theories of dividend payout.

Other papers, however, suggest that either managers responding to these surveys do not articulate well what they do, or they respond to cues that they do not fully understand. It seems that tax, agency, and clientele rationales are alive and well in the data. Chetty and Saez (W10572) test the tax theory by asking whether dividend payments increased after the individual income tax on dividends was cut in 2003. They find that more firms initiated dividends for the first time and that many firms increased the dividends they already paid. This finding is robust to the usual controls. While others have found similar responses to tax changes in the past, the fact that the long decline in dividend payment in the United States seems to have turned around, and for a traditional reason, is particularly interesting.

Desai, Foley and Hines (W8698) examine the dividend policies of foreign affiliates of U.S. multinational firms. They find that they are not only determined by tax considerations, but also by agency considerations: foreign affiliates that are only partly owned, located far from the United States, or in areas where property rights are weak, typically pay more in dividends (presumably because they cannot be trusted to keep the cash, given the parent's weak control). DeAngelo, DeAngelo, and Stulz (W10599) argue that if firms did not pay out dividends, they would sit on a mountain of cash with attendant incentives to waste it. They find that firms with large amounts of retained earnings tend to pay dividends, even after one controls for their profitability and growth.

Finally, Baker and Wurgler (W9542) find that firms tend to initiate dividends when the demand for dividends is high, as measured, for example, by the difference between the market to-book ratio of dividend paying firms and non-dividend paying firms. They suggest that there are fluctuations in investor sentiment about dividends, and that firms cater to this. Of course, what they term investor sentiment may well be time-varying concerns about agency or taxes (as would occur, for example, if firms built up cash piles during cyclical upturns and ran them down in downturns). The authors do a number of tests to rule it out. Nevertheless, one could still have questions about the findings: if indeed investors become enthused about dividends when sentiment is high, then it is surprising that firms do not raise the aggregate payout ratio. However, this is a novel explanation that deserves further investigation.

Capital Structure

Many battles have been fought over capital structure: whether firms truly have a target capital structure that they adhere to fairly strictly; whether firms have high costs of issuing equity which they factor into decisions about how close they should be to the target; and finally whether firms are simply buffeted by market forces and do not really bother about capital structure. Welch (W8782) takes the last view, and shows that the ratio of debt to market value of assets for firms is determined strongly by past equity, returns and little else. One could take issue with whether debt-to-market-value is the appropriate measure of capital structure, but Welch offers some arguments in support. Kayhan and Titman (W10526) soften Welch's basic finding by arguing that even though history (for example, through past movements in the stock price) tends to influence capital structure changes, the effects eventually are reversed, and firms do tend to make financing choices that move them towards target debt ratios.

Stock Market and Investment

The recent boom and bust in the stock market, and evidence of excessive investment in certain sectors like telecommunications, has led some to ask if we should revisit the received wisdom that the stock market is a sideshow to real activity. Polk and Sapienza (W10563) find that over-priced firms do tend to overinvest, and then tend to have low stock returns. Gilchrist, Himmelberg, and Gur (W10537) argue that stock prices rise above fundamentals when investor beliefs are more dispersed, and short-selling constraints prevent the most pessimistic among them from registering their vote. They find that firms with more dispersed investor beliefs have higher new equity issues and investment. Both papers suggest that high stock prices push managers into investing by reducing their cost of finance. One problem with this interpretation is that high stock prices also may be signaling the value of future opportunities, and this may be why firms invest. Baker, Stein...