An option pricing approach to corporate dividends and the capital investment financing decision. Issue 4 (22nd April 2019)

• Record Type: Journal Article
• Authors: Chance, Don M.
• Is Part Of: Review of financial economics. Volume 37:Issue 4(2019)
• Page Start: 541
• Page End: 553
• Publication Date: 2019-04-22
• Subjects: contingent claims -- dividend policy -- dividends -- options; Business -- Periodicals; Economics -- Periodicals; Business; Economics; Electronic journals; Periodicals; 332.05
• DOI: 10.1002/rfe.1060
• Languages: English
• ISSNs: 1058-3300

Abstract

Abstract: In light of a growing trend toward viewing dividends as an investable asset class, this article opens up a new perspective on their valuation. We show that dividends can be viewed as options on the cash flow of the firm. That is, a firm either pays zero dividends, in which case the option expires out‐of‐the‐money, or it pays a positive dividend, the value of which corresponds to the option's moneyness. The exercise price is determined by the capital budget, the flexibility of the company to use external financing, and whether it has minimum and maximum dividends. The model is also capable of accommodating a stochastic capital budget, which allows for uncertain growth opportunities and their correlation with the firm's cash flows. We also present an application of the model using actual data for a large multinational company.