Working Paper Series, Department of Economics, Uppsala University
No 2002:9:
The Marginal Source of Finance
Tobias Lindhe
Abstract: This paper addresses the ongoingdebate on which view of
equity, traditional or new, that best describes firm behavior. According to
the traditional view, the marginal source of finance is new equity, whereas
under to the new view, marginal financing comes from retained earnings. In
the theoretical part, we set up a model where the firm faces a cost of
adjusting the dividend level because of an aggravated free cash flow
problem. The existence of such a cost - which has been used in arguing the
traditional view - does not invalidate the core of the new view, namely
that the marginal investment may be financed with retained earnings. The
combination of costly changes in dividends and retained earnings as the
marginal source of funds actually defines an extended new view of equity.
In the empirical part, we test the implication of the new view that
dividends and investments are negatively related. The overall conclusion is
that the implication of the new view is supported for traded Swedish firms
during 1980-98.
Keywords: The traditional view of equity; the new view of equity; financing policy; payout policy; (follow links to similar papers)
JEL-Codes: G32; G35; H32; (follow links to similar papers)
24 pages, May 2, 2002
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