Shareholder Heterogeneity, Adverse Selection, and Payout Policy

Journal of Financial and Quantitative Analysis, June 1998

Posted: 4 Jun 1998

Abstract

When shareholders have different plans to sell their shares, they will, in general, have different preferences concerning the firm's decision to pay out cash using dividends or share repurchase. We illustrate these different preferences and explore a model of payout policy that highlights the adverse selection costs of repurchases when managers have superior information about the value of the firm. We show that, in the absence of fixed costs to repurchasing shares, there is a separating equilibrium in which managers use taxable dividends to signal the quality of the firm, with better firms paying lower dividends, using repurchases for the remainder of the payout. With fixed costs to repurchasing, small payouts are made via dividend and large payouts are divided between repurchases and dividends, as in the no-fixed cost case. In both cases, the percentage of shares repurchased increases with the size of the payout and larger repurchases are better news.

JEL Classification: G31, G35

Suggested Citation

McDonald, Robert L. and Lucas, Deborah J., Shareholder Heterogeneity, Adverse Selection, and Payout Policy. Journal of Financial and Quantitative Analysis, June 1998, Available at SSRN: https://ssrn.com/abstract=93628

Robert L. McDonald (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8344 (Phone)
847-491-5719 (Fax)

Deborah J. Lucas

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8333 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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