Capital Expenditure and Payout Policy

Subramanian Rama Iyera Harry Fengb

Ramesh P. Raoc

_____________________________ a FITE Department, Anderson School of Management, University of New Mexico, Albuquerque,

NM 87111. Email: sriyer@unm.edu, Tel: 505-277-3207 b Department of Finance, Spears School of Business, Oklahoma State University, Stillwater, OK

74078. Email: harry.feng@okstate.edu, Tel: 405-744-5199 c Department of Finance, Spears School of Business, Oklahoma State University, Stillwater, OK

74078. Email: ramesh.rao@okstate.edu, Tel: 405-744-1385

Capital Expenditure and Payout Policy

Abstract

Managerial perception as well as empirical evidence suggests that repurchases are inherently more flexible than dividends. The rigidity of dividends and the apparent flexibility of share repurchases could impact firm investments. Firms may forego profitable investment opportunities to maintain their dividend level, while repurchases could be easily scaled back to fund profitable investment projects without fear of an adverse market reaction. We test the flexibility hypothesis of repurchases by regressing capital expenditures on repurchases and dividends in addition to other control variables. Consistent with the hypothesis, we find an inverse relationship between capital expenditures and repurchases but an insignificant relationship with dividends. Further, we find that the flexibility associated with repurchases is prevalent for firms with high financial constraints and in the more recent time period when repurchases became popular.

JEL Classification code: G35

Keywords: payout policy, stock repurchases, stock buybacks

I. Introduction

Over the years share repurchases1 have become an important mode of payout. Firms that

initiate payouts show an increasing propensity to repurchase stock than to pay dividends. Even

dividend paying firms over time have increased the proportion of share repurchases in their total

payout (Grullon and Michaely (2002)). The increased preference for share repurchases over

dividends could be due to many reasons. One that has received considerable attention, and the

focus of this study, is the flexibility that repurchases accord but dividends do not. Very simply,

by flexibility we mean that repurchases do not engender a commitment on the part of the firm to

continue to make payouts once initiated or to raise them periodically once initiated. Dividends

on the other hand are assumed to have this implicit commitment. The flexibility of repurchases

can have real consequences, especially when firms face financial constraints. It enables firms to

curtail or even eliminate buybacks when there is a need to preserve liquidity or to pursue

profitable investment opportunities without fear of being penalized by the market.

The notion of flexibility is supported by survey and empirical evidence. Brav, Graham,

Harvey, and Michaely (2005) survey financial executives and find that managers like the

flexibility of share repurchases and dislike the rigidity of dividends. Survey results reveal that

this preference for repurchases stems from the view that once a firm initiates a dividend, it is

expected to continue to pay dividends. However, share repurchases are not viewed as being

subject to a similar expectation. While most managers agree that reducing dividends will draw

negative abnormal market reaction, only a small proportion of financial executives consider

reducing repurchases as having such an adverse consequence.

1 We consider only open market repurchases and do not address other modes of share repurchases such as Dutch auctions or tender offers.

Consistent with the reservations expressed by managers on dividends, Fama and French

(2001) note that the proportion of firms paying cash dividends has decreased drastically. They

document a lower propensity to pay dividends even after controlling for the observed tilt in listed

firms towards firm characteristics that do not favor payment of dividends – small, low earnings,

and high investment firms. They also state that the perceived value from paying dividends has

declined. Grullon and Michaely (2002) and Jagannathan, Stephens, and Weisbach (2000) find

that share repurchases have increased in prominence compared to dividends. Grullon and

Michaely (2002) document that large, established firms have not decreased their dividend

payouts, but they display a higher propensity to pay out cash through share repurchases.

Together, these two papers find that the increase in share repurchases can explain the decreasing

propensity to pay dividends, which also corroborates the survey evidence in Brav et al., (2005).

However, none of these studies explicitly tests the flexibility hypothesis. The flexibility offered

by share repurchases could be a primary factor explaining why firms choose to repurchase shares

instead of paying dividends.

In this paper we test the relative flexibility of repurchases and dividends by focusing on

how flexibility affects firms’ investment activity. Specifically, we test the sensitivity of capital

expenditures to dividends and repurchases. In brief, we document a negative coefficient for

repurchases and a generally insignificant coefficient for dividends when capital expenditures are

regressed on the two forms of payout and other control variables. The inverse relationship

between capital expenditures and repurchases suggests that when investments needs are high

firms scale back on repurchases and vice-versa. The insignificant coefficient for dividends on

the other hand implies that dividends are not secondary to capital investments. Further, we

expect and find that the flexibility of repurchases is stronger for firms that are more constrained.

Finally, not surprisingly, we find that support for flexibility is stronger in the second half of the

sample period (1992-2012) when repurchases became much more popular.

The remainder of the paper is organized as follows. The next section presents the

hypotheses. Section 3 describes the methodology and sample construction. Section 4 presents the

empirical results while section 5 concludes.

II. Hypotheses development

The flexibility offered by share repurchases can be classified into short term flexibility

and long term flexibility. In the short term, a firm that announces an open market share

repurchase program may choose not to carry through with the promise. Once a repurchase

program has been announced a firm may opt not to repurchase any stock under the program and

it may divert the cash earmarked for repurchases to some other avenue. Alternately, the firm may

opt to repurchase only a fraction of the amount sought during the announcement of the program.

In the long term, a firm that distributes excess cash flow through share repurchases may choose

not to announce a share repurchase program every year. The firm is also not expected to

maintain the same level of share repurchases as the previous year. The firm may choose to

increase or decrease the amount spent on share repurchases.

On the other hand, dividends do not offer the firm such flexibility. Managers consider

dividends to be fairly rigid (Brav, Graham, Harvey and Michaely (2005 )). Once a firm initiates

dividends it is expected to continue this course of action, which acts as a disincentive to initiate

dividends in the first place. In other words, once dividends have been initiated, a firm is expected

to distribute dividends each year. It is also expected that firms increase dividends each year, or at

least maintain the level of dividends paid in the previous period. Firms contend that there is not

much reward when they raise dividends. With dividends, firms believe that the cost of altering

course by reducing dividends is greater than the cost of maintaining it. Any reduction in the

dividend is interpreted as a sign of an ominous future and share prices tumble once a dividend

reduction is announced. Therefore, firms will opt to cut dividends only under extreme

circumstances.

Maintaining dividends thus assumes top priority and any increases in dividends are

considered to be second order. Under these circumstances, one has to infer that dividends are not

treated as residual cash flows. Dividend decisions will be made at least simultaneously along

with investment decisions, if not earlier. Such a conservative dividend policy means that firm

investments could suffer if it boils down to a choice between maintaining dividends and

investment spending. A portion of the cash flow will be apportioned towards dividends as well as

necessary investments. To the extent that dividends impose a binding constraint on the firm’s

cash flows, the firm may not invest adequately if cash flow is not sufficient to support both

dividends and investments and if there is a constraint in accessing external capital. Consistent

with this notion, managers interviewed by Brav et al. (2005) expressed the view that they might

pass up some positive net present value (NPV) projects before cutting dividends. Some

expressed the willingness to raise external capital to fund investments without cutting dividends.

Raising external capital is costly. The fact that managers are willing to raise external capital

instead of cutting dividends to support investments lends further support to the view that

dividends could be a binding constraint that may hamper necessary investments. This view is

also supported by Daniel, Denis and Naveen (2010) who find that only 6% of the firms in their

sample cut dividends when faced with a cash flow shortfall. Interestingly, 68% of firms opt to

make significant cuts to investments. More formally, dividend inflexibility leads to the following

testable hypothesis:

H1: Dividends and investments are not inversely related.

Unlike dividends, firms may not feel as constrained with share repurchases. While

dividend payout ratio targets have been widely talked about, there is hardly any mention of a

share repurchase ratio target in the academic world or in the business press. The dividend paying

history of a firm also determines the decision to pay dividends. However, the share repurchase

history of a firm is hardly been indicated as a motivation to repurchase shares. Firms may not

feel as burdened with the history of shares repurchases when it comes to their current decision on

share repurchase programs. While dividends may be simultaneously determined along with

investments, share repurchases are decided once necessary investments and liquidity needs have

been met. To that extent, share repurchases are truly residual cash flows. Firms could cut share

repurchases to support any positive NPV projects without the fear of any adverse market

reaction. Therefore, the ability of share repurchases to adversely impact firm investments is

expected to be negligible. The flexibility of repurchases implies the following testable

hypothesis:

H2: Repurchases and investments are inversely related.

The flexibility argument presumes that external financing is costly. If accessing external

markets is costless, payout policy would not matter. Firms following a rigid dividend policy will

not have to sacrifice or forego profitable investment opportunities as they can easily finance

these by accessing the external capital markets. Thus a repurchasing payout policy does not

confer any flexibility advantage over a dividend payout policy. There is considerable amount of

research on how financial constraints affect investments. Much of this literature focuses on the

sensitivity of investments to cash flow. The idea being financially constrained firms have to

primarily rely on internal cash flow sources, therefore for these firms investments will be much

more sensitive to internal cash flows than unconstrained firms. In a seminal paper Fazzari,

Hubbard, and Petersen (1988) document a greater sensitivity of investment to cash flows for

financially constrained firms even after controlling for growth opportunities. Using participation

in the capital markets (debt) as an indicator of financial constraint, Gilchrist and Himmelberg

(1995) find that firms that did not participate had very high sensitivity of investments to cash

flow.2

Based on the above, the flexibility argument for repurchases should be stronger when

financial constraints are more severe. This leads to our third testable hypothesis:

H3: The inverse relationship between repurchases and investments will be stronger for

more financially constrained firms.

Our final hypothesis examines the change in the sensitivity of investments to repurchases

over time. There are several reasons why the sensitivity may change over time. Fama and

French (2001) find that the propensity of firms to pay dividends dropped from 66.5% in 1978 to

20.8% in 1999. They attribute this decline in propensity to changing characteristics of firms such

as a shift towards smaller, low profitable, and high growth firms. Grullon and Michaely (2002)

2 Not everyone agrees with the interpretation that higher sensitivity of investments to internal cash flows is

associated with higher constraints. Kaplan and Zingales (1997) find that the least constrained firms exhibit higher investment-cash flow sensitivity than firms that are classified as more financially constrained. They state that cash flow may act as a proxy for investment opportunities and the presence of outliers may explain the conflicting results found by Fazzari et al. (1988). Classifying firms a priori into different groups by size, Kadapakkam, Kumar and Riddick (1998) use an international sample and find that the investment-cash flow sensitivity is lowest in the small firm group and highest among the large firms, which is also confirmed by Cleary (1999). On the other hand, Allayannis and Mozumdar (2004) show that Kaplan and Zingales’ (1997) results may have been influenced by possible outliers and by firms that face financial distress. Using negative cash flows as proxy for financial constraints and by removing some of the outliers in the Kaplan and Zingales (1997) study, Allayannis and Mozumdar (2004) find results that are more in line with Fazzari et al. (1988). Using simulated data Alti (2003) demonstrates that investment and cash flow can be closely related even when financing is frictionless. While these studies question the interpretation of the sensitivity of investments to cash flow as an indication of the impact of financial constraints on investments, they do not suggest that financial constraints do not impact investments.

propose the substitution hypothesis stating that repurchases have replaced dividends as the

preferred mode of payouts for many firms. In part, this is attributed to the Securities and

Exchange Commission adoption of 10b-18 Safe Harbor Rules in 1982. This rule provided safe

harbor from liability for manipulation security prices. The shift to repurchases, motivated in part

by regulatory changes and the greater desire for flexibility, suggests that the flexibility effect of

repurchases should be stronger over the latter part of the sample period. This leads to our final

testable hypothesis:

H4: The inverse relationship between repurchases and investments will be stronger for

latter half of the sample period.

III. Empirical Methodology and Data

Our empirical methodology is straightforward. We regress capital expenditures on

repurchases and dividends, and a host of control variables.

������,� =�� �����ℎ�����,� + ������������,� + ��� !"�#$%"&%'#()&,! +*�,� (1)

All variables are measured annually. Our main test variable, Repurchases is defined per Grullon

and Michaely (2002) as cash expenditures on the purchase of common and preferred stock minus

any reduction in the book value of preferred stock. This measure has further been used in other

papers including Billet and Xue (2007), and Lie (2005). Dividends is defined as the total cash

dividends paid per year. Next we discuss the control variables. Size, is defined as the log of firm

assets. Leverage is defined as the sum of long term debt and short term debt scaled by the total

assets net of cash equivalents. Market to Book, which captures the growth potential of a firm, is

defined as the sum of market value of shares and total assets net of cash equivalents and common

equity. The resultant value is scaled by the total assets net of cash equivalents. TANGIBILITY, a

measure of borrowing capacity, is defined per Almeida and Campello (2007) as follows:

+��,�-�.�/0 = (0.715 × �� + 0.547 × 9��/ + 0.535 × ���)/(+=/����/� − ���ℎ)

(2)

where Rec, Invt, PPE, Tot assets and Cash are receivables, inventory, net property plant and

equipment, total assets, and cash and equivalents, respectively. Our final variable, which we

include to control for internal cash availability, Cash Flow, is defined as operating income before

depreciation and scaled by total assets net of cash equivalents. All of the above mentioned

variables are taken from Compustat.

Our sample construction requires some explanation. Since our primary goal is to test for

flexibility of repurchases, we focus on firms that engage in buybacks. Specifically, our base

sample consists only of firm year observations which show repurchase activity between 1971

and 2012. That is, we exclude all firm year observations that do not contain repurchase activity.

We relax this to some degree in our robustness tests. The primary reason for eliminating non-

repurchasing firms is because the sensitivity of investments to repurchases will be obscured if

there are an overwhelming number of non-repurchasing firms in the dataset. This is especially

true in the first part of the sample when repurchases are fairly rare events. Most of the

repurchases in the first part of the sample period, especially in the 1970s and early 1980s, tend to

occur for signaling purposes rather than as a result of a firm’s payout policy. In the latter period,

though repurchases became much more popular, there was an explosion of companies that went

public did not have any established payout policy (Fama and French 2001).

One could argue that by keeping only firms that made a repurchase in a given year, we

are biasing our sample to repurchasing firms and away from dividend paying firms. This is only

partly true. Many of the repurchasing firms also pay out dividends, thus we are only excluding

firms that paid out dividends but did not engage in repurchases. This too is by design. We

exclude firms that follow an exclusive policy of paying out dividends (and not engage in

repurchases) because they may be fundamentally different from repurchasing firms, e.g., their

growth requirements are nominal and may be fully funded through internal cash flow. Including

them could lead to confounding results. If higher dividend payout firms are associated with

lower growth and lower capital expenditures, this would yield an inverse relationship between

dividends and capital expenditures but is not an indication of flexibility. However, we are still

able to test for the relative flexibility of dividends as called for in our first hypothesis. We are

able to do this because many firms that repurchase shares also disburse cash to their shareholders

via cash dividends. This actually allows us to conduct a more meaningful test of the relative

flexibility of dividends and repurchases because the same firm serves as a control. That is, by

comparing the relative use of dividends and repurchases by the same firm we need not worry

about combining what may be two fundamentally different groups of firms that find it optimal to

use follow an exclusive payout policy.

Our empirical methodology also requires a method to identify a firm’s degree of financial

constraint. Recall that hypothesis 3 proposes that the need for payout flexibility will be

especially important for highly financially constrained firms. There are several proxies to

measure a firm’s degree of financial constraint. Two measures that have been widely used in the

literature are the the KZ index and the WW index. (Lamont et. al 2001, Whited and Wu 2006)

Summary Statistics

Table 1 – panel A presents the summary statistics of firms in the sample. The sample

firms on average invest 7.24% (4.71% median) of total assets in capital assets and spend 3.48%

(0.97% median) of total assets on share repurchases. On the other hand, sample firms on average

pay 1.53% (.07%) of their total assets as dividends. Thus, many firms that buyback shares also

pay out dividends. Recall that these averages are not for all firms but rather for firm year

observations that show repurchase activity.

The average firm in our sample has $2,053 million in assets ($66.32 million) with a range

of $6.6 million and $667.3 million between the lowest quartile and highest quartile. Leverage for

the firms in our sample ranges from 4.26% to 34.08% between the lowest quartile and highest

quartile. Firms in our sample have high growth potential as reflected in the average market to

book ratio of 2.11 (1.28 median). This is consistent with the fact that our sample is restricted to

firms that repurchased stock, which in general tend to have higher growth potential than non-

repurchasing firms. The sample firms have a healthy cash flow averaging 6.00% (8.32%

median) of total assets. Fixed assets on average make up 36.38% (39.54%) of total assets. The

average age of the sample firm is 15 years (12 years) and some of the oldest firms being in

existence for more than 22 years and some of the youngest firms being in existence for only less

than 6 years.

Panel B presents the correlation statistics between the test variables and control variables.

It is interesting to note that capital expenditures are negatively correlated with repurchases

consistent with the flexibility argument. However, dividends also exhibit a similar negative

correlation with capital expenditures. Larger firms and older firms appear to spend less on

capital expenditures while higher cash flows are associated with higher capital expenditures.

There is also a positive relationship between tangibility and capital expenditure, which is

expected. The correlation matrix also reveals that multicollinearity is not likely to be a problem

based on the pair-wise correlations between the various independent variables.

[Insert Table 1 about here]

IV. Results

Hypotheses 1 and 2

Table 2 presents estimates of equation (1) which we use to test hypotheses 1 and 2. Our focus is

on the significance and sign of the coefficient for Repurchases and Dividends. Columns 1

through 3 provide coefficient estimates for equation (1) but vary depending on the fixed effects

employed—year, industry, and industry and year, respectively. In all three columns we find that

capital expenditures and repurchases are significantly negatively related. On average a one

percent decline in repurchases is associated with an increase of 0.04% in capital expenditures.

This supports hypothesis 2 that firms curtail repurchases to fund capital investment needs. On

the other hand we observe that the coefficient for Dividends is insignificant supporting

hypothesis 1 that firms do not adjust dividends in response to their investment needs. Recall that

our sample consists of firms that engage in buybacks and may also distribute dividends on a

regular basis. Based on the evidence in Table 2 columns 1-3, it is apparent that firms adjust their

repurchases depending on their capital expenditure needs but the same firms in all likelihood

leave their dividends untouched or view them independent of their capital expenditure decisions.

With regard to the control variables, firms with high market to book and high tangibility

tend to spend more on capital expenditures, which is to be expected. Older firms have lower

capex requirements while lower leverage is associated with higher capital expenditures. While

the latter may be surprising it is consistent with Myers’ pecking order theory and the flexibility

argument. The higher agency and information costs of external capital induces firms to redirect

funds that could have been used to repurchase shares to capital expenditures.

Columns 4-5 present estimates of equation (1) but consider an extended sample of firms.

The base sample considers only firm year observations that had non-zero repurchase values. Our

sample excludes firms that have a positive repurchase activity in a given year but choose to

eliminate repurchases the following year, perhaps to fund capital expenditure or other needs.

While this makes our estimates in columns 1-3 more conservative, previously repurchasing firms

that choose not to repurchase stock temporarily should also be viewed as firms that value the

flexibility of repurchases. Accordingly, in columns 4-5 we extend our base sample to include

two more years of data for each firm. Column 5 additionally treats negative net repurchases as

zero repurchases. We do this to ensure that the inverse relationship between repurchases and

capital expenditures is not driven by net issuing firms (negative repurchases) that may be using

the funds to increase investments.

Our core findings are unaffected by the extended sample used in columns 4-5. The

coefficient for Repurchases is unchanged with a negative sign supporting the flexibility

hypothesis while the coefficient for Dividends is still insignificant. Thus across all the

estimations in Table 2 we find support for the flexibility hypothesis, that is, repurchases are

curtailed when investment needs are high whereas we don’t find such a relationship for

dividends.

[Insert Table 2 about here]

Hypothesis 3

We now examine the potential moderating role of financial constraints on the flexibility of

repurchases. Firms with low financial constraints may have access to external capital sources to

continue their payouts without any disruptions to their capital investments. On the other hand

firms that rank high on financial constraints either have to forgo profitable opportunities or, as

we argue in this hypothesis, have the opportunity to redirect their payouts to more profitable

investments.3 Our second hypothesis tests the above mentioned contention. To test this

hypothesis, as discussed previously, we utilize the KZ and WW financial constraint indexes. We

calculate the KZ index and WW index for each firm every year and classify firms into low and

high financial constraint subsamples using the median values of the respective indexes for each

year. We then estimate equation (1) separately for the low and high constraint subsamples.

[Insert table 3 about here]

Results are presented in Table 3. Columns 1 and 2 (3 and 4) present regression estimates

for the low and high financial constraint subsamples using the KZ (WW) index, respectively.

The coefficient for Repurchases is significantly negative for the high constraint subsample using

either index. On average, for firms with high financial constraint according to the KZ index

(WW index) a 1% reduction in repurchases is associated with a 0.04 % (0.03%) increase in

capital expenditures. The coefficient for Repurchases is either insignificant or positively

significant in the low financial constraint subsample. These findings are consistent with our

hypothesis that the flexibility associated with repurchases primarily manifests itself when firms

are highly constrained. In the case of dividends, the coefficient is insignificant for both low and

high KZ index subsamples, and the low WW index subsample but surprisingly exhibits a

negative significant coefficient for the high WW index group though the significance is only at

the 10 percent level.

Overall, Table 3 tells us that with low financial constraints firms’ payouts (dividends or

repurchases) are independent of capital expenditures or even positive. Flexibility for payout

policy should not matter for these firms since they are presumed to have sufficient access to

capital markets to meet their investment needs. On the other hand, payout flexibility appears to

3 There are other options that firms may avail including asset sales, alliances, etc.

matter for firms with higher financial constraints that do not have easy access to external

financial markets. The significant negative coefficient for Repurchases for high constraint firms

suggests that these firms curtail their repurchases to fund capital expenditures.

Hypothesis 4

In our final test we estimate the capital expenditure-payout relationship for the sample classified

by time. We hypothesize that the flexibility associated with repurchases will be stronger in the

second half of the sample period. As hypothesized, repurchases became much more common

starting in the 1980s because of easier regulation and presumed awareness of their flexibility.

Table 4 column 1 (2) present estimates of equation (1) for the 1971-1991 (1992-2002)

subperiods. Consistent with our expectation the coefficient for Repurchases is significantly

negative for the second subperiod but insignificant in the first subperiod. Interestingly, the

coefficient for Dividends is significantly negative in the first subperiod when we expected it to

be non-negative in both subperiods.

[Insert table 4 about here]

V. Conclusions

Managers consider share repurchases to be more flexible than dividends, which may

account for the increased popularity of repurchases over dividends in the past two decades.

Survey evidence indicates that managers perceive dividends to be permanent commitments while

repurchases are assumed to be flexible. As a result firms may be constrained by their dividend

policy. When internal cash flow is insufficient to meet investment needs, a firm has several

options: reduce its investments and continue its payouts, raise external capital to support the

investment, or reduce payouts to support the investment. If firms are constrained from cutting

their dividend, then investments may be pared back. On the other hand, because repurchases are

viewed to be flexible managers may tend to adjust their repurchase activity to meet capital

expenditure needs without worrying about investor backlash.

We test the flexibility hypothesis by regressing capital expenditures on repurchases and

dividends. Consistent with the hypothesis we find that capital expenditures are inversely related

to repurchases but not to dividends. We also find that the inverse relationship manifests itself in

high financial constraint firms but not in low constraint firms. Finally, we observe that the

repurchase flexibility hypothesis is prevalent in the second half of the sample period when

buybacks were much more common. Overall we conclude that share repurchases are more

flexible than dividends.

Appendix 1 – This table describes the main control variables that will be used in testing our hypotheses.

Variable Name Description Data Source

CAPEX Capital Expenditures scaled by total assets COMPUSTAT

REPURCHASES Cash expenses on purchase of common and preferred stock minus any reduction in book value of preferred stock scaled by total assets

COMPUSTAT

DIVIDENDS Cash dividends scaled by total assets COMPUSTAT

SIZE Natural log of total assets COMPUSTAT

LEVERAGE Sum of long term debt and short term debt scaled by total assets net of cash equivalents

COMPUSTAT

MTB Sum of market value of shares and total asset net of cash equivalents and net of common equity scaled by total assets net of cash equivalents

COMPUSTAT

CASH FLOW Operating income before depreciation scaled to total assets net of cash equivalents

COMPUSTAT

TANGIBILITY Weighted value of sum of book value of a firm's receivables, inventory and capital scaled by total assets net of cash equivalents

COMPUSTAT

AGE Number of years since a firm first appeared on COMPUSTAT

COMPUSTAT

References

Almeida, H., and M. Campello. 2007. Financial Constraints, Asset Tangibility, and Corporate Investment.

Review of Financial Studies 20, 1429–1460.

Billett, M., and H. Xue, 2007, Share repurchases and the need for external finance, Journal of Applied

Corporate Finance 19, 42–55

Brav, Alon, John R. Graham, Campbell R. Harvey, and Roni Michaely, 2005, Payout policy in the 21st

century, Journal of Financial Economics 77, 483-527.

Brav, Alon, John R. Graham, Campbell R. Harvey, and Roni Michaely, 2005, Payout policy in the 21st

century, Journal of Financial Economics 77, 483-527.

Daniel, Naveen D., D. J. Denis, and Lalitha Naveen, 2010, Sources of financial flexibility: Evidence from

cash flow shortfalls, (Drexel University).

Fama, Eugene F., and Kenneth R. French, 2001, Disappearing dividends: Changing firm characteristics or

lower propensity to pay?, Journal of Financial Economics 60, 3-43.

Fazzari, S. M., R. G. Hubbard, and B. C. Petersen, 1988, Financing constraints and corporate-investment,

Brookings Papers on Economic Activity 141-195.

Gilchrist, Simon, and Charles P. Himmelberg, 1995, Evidence on the role of cash flow for investment,

Journal of Monetary Economics 36, 541-572.

Grullon, G., and R. Michaely, 2002, Dividends, share repurchases, and the substitution hypothesis,

Journal of Finance 57, 1649-1684.

Jagannathan, M., C. P. Stephens, and M. S. Weisbach, 2000. Financial flexibility and the choice between

dividends and stock repurchases. Journal of Financial Economics 57, 355–84.

Kaplan, S., and Per Stromberg, 2003, Financial contracting theory meets the real world: Evidence

from venture capital contracts, Review of Economic Studies 70, 281–315.

Kaplan, Steven N., and L. Zingales, 1997, Do investment—cash flow sensitivities provide useful

measures of financing constraints? Quarterly Journal of Economics 112, 169–215.

Lamont, O., C. Polk, and J. Saa-Requejo, 2001, Financial constraints and stock returns, Review of

Financial Studies 14, 529–554.

Lie, E. 2005. On the timing of CEO stock option awards. Management Science 51, 802–812.

Whited, T., 1992, Debt, liquidity constraints and corporate investment: Evidence from panel

data, Journal of Finance 47, 425–460.

Whited, T., and G. Wu, 2006, Financial constraints risk, Review of Financial Studies 19, 531–559.

Table 1 Descriptive statistics and correlations of firm net repurchase and firm characteristics. The sample includes all continuous non-positive net repurchase firm-years in the CRSP and Compustat database during the period 1971 to 2012. The sample excludes financial and utility firms. Panel A reports descriptive statistics, and Panel B reports Pearson correlation coefficients. Net repurchase and all control variables are winsorized at the 1st and 99th percentiles. ***, **, and * in Panel B denote significance at the 1%, 5%, and 10% levels, respectively.

Panel A

Descriptive Statistics

Variable N Mean Std Dev 1st Quartile Median 3rd Quartile

Capex 74,886 0.0724 0.0869 0.0188 0.0471 0.0921

Repurchases 75,820 0.0348 0.0690 0.0022 0.0097 0.0344

Dividends 75,618 0.0153 0.0334 0 0.0007 0.0185

Size 75,228 2053.8 8111.18 6.5912 66.3275 667.2796

Leverage 75,496 0.2240 0.2093 0.0426 0.1836 0.3408

Market to Book 69,417 2.1152 3.5236 0.9927 1.2827 2.0387

Cash Flow 74,099 0.0600 0.1675 0.0311 0.0832 0.1304

Tangibility 72,022 0.3638 0.1521 0.2579 0.3954 0.4858

Age 75,606 15.7094 13.3426 6 12 22

Panel B

Correlation between cash, CEO incentives, and firm characteristics

Variable Capex Repurchases Dividends Firm Size Leverage

Market to

book Cash Flow Tangibility Firm age

Capex 1

Repurchases -0.0071** 1

Dividends -0.0065*** 0.0148*** 1

Size -0.1401*** -0.0215*** -0.0106*** 1

Leverage -0.002 0.0224*** -0.0003 -0.0221*** 1

Market to

book -0.0042 0.0770*** -0.0001 -0.03*** 0.2461*** 1

Cash Flow 0.0079** 0.4018*** 0.0012 0.0329*** -0.4785*** -0.3537*** 1

Tangibility 0.1677*** -0.0088** -0.0259*** -0.1081*** -0.0021 -0.0150*** 0.0097*** 1

Firm age -0.0793*** -0.0056 0.0016 0.4556*** -0.0027 -0.0065* 0.0065* 0.0129*** 1

Table 2 Regressions of Capex on Repurchases and control variables. The dependent variable is the ratio of Capex to Net Assets. All independent variables are defined in section on Data and descriptive statistics. Models 1–3 regresses Capex in fiscal year t on net repurchase in year t. Models 4-5 regress Capex in fiscal year t on net repurchase in year t. We keep the Repurchases year and following three years after the repurchase in model 4-5. In model 4, net issuance of equity is treated as negative net repurchase. In model 5, we treat the net equity issuance as zero. Industry dummies are based on two-digit Standard Industrial Classification codes. T-Statistics are in parentheses. The t-statistics are based on heteroskedastic-consistent standard errors. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Independent variable Repurchase

year (1) Repurchase

year (2) Repurchase

year (3) Three years (4) Three years (5)

Repurchases -0.0004 -0.0004 -0.0004 -0.0004 -0.0004

(-2.76)*** (-3.01)*** (-2.93)*** (-2.92)*** (-2.97)***

Dividends -0.0002 -0.0002 -0.0002 -5.2E-05 -5.3E-05

(-0.73) (-0.96) (-0.91) (-0.82) (-0.84)

Firm Size -0.0024 -0.0022 -0.0014 0.0001 0.0001

(-14.61)*** (-14.16)*** (-8.72)*** (0.79) (0.93)

Leverage -0.0002 -0.0001 -0.0001 -0.0173 -0.0180

(-5.15)*** (-4.67)*** (-4.72)*** (-13.6)*** (-14.26)***

Market to book 0.0012 0.0009 0.0010 0.0030 0.0030

(16.24)*** (13.87)*** (14.35)*** (30.75)*** (31.18)***

Cash Flow -2.2E-06 -2.6E-06 -1.4E-05 0.0039 0.0032

(-0.05) (-0.07) (-0.37) (3.2)*** (2.67)***

Tangibility 0.0543 0.0571 0.0433 0.0485 0.0483

(24.04)*** (23.91)*** (17.57)*** (24.07)*** (24.28)***

Firm age -0.0005 -0.0006 -0.0006 -0.0007 -0.0007

(-18.96)*** (-23.26)*** (-22.48)*** (-31.41)*** (-31.95)***

Intercept 0.0814 0.0814 0.0857 0.0793 0.0797

(63.73)*** (59.82)*** (62.24)*** (70.68)*** (71.69)***

Industry dummies No Yes Yes Yes Yes

Year dummies Yes No Yes Yes Yes

Number of observations 64,349 64,349 64,349 95,350 95,350

Adj.R^2 0.06 0.18 0.19 0.19 0.19

Table 3 Regressions of Capex on Repurchases and Financial Constraints. The dependent variable is the ratio of Capex to Net Assets. All independent variables are defined in section on Data and descriptive statistics. Models 1–2 regress Capex in fiscal year t on net repurchase in year t. We separate the dataset into two subsamples by the median KZ index of each year. Models 3-4 repeat the same analysis with WW index. Industry dummies are based on two-digit Standard Industrial Classification codes. T-Statistics are in parentheses. The t-statistics are based on heteroskedastic-consistent standard errors. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Independent variable Low KZ Index (1) High KZ Index (2) Low WW Index(3) High WW Index(4)

Repurchases 0.0028 -0.0004 0.0086 -0.0003

(0.64) (-2.56)*** (2.27)** (-2.3)**

Dividends -5.9E-05 -0.0009 0.0002 -0.0007

(-0.29) (-1.45) (1.25) (-1.76)*

Log firm size -2.76E-08 1.36E-07 -2.16E-08 8.56E-08

(-1.37) (2.19)** (-1.41) (1.18)

Leverage -0.0317 -8.6E-05 -0.0222 -9.6E-05

(-13.81)*** (-2.76)*** (-12.73)*** (-3.02)***

Market to book 0.0071 0.0006 0.0068 0.0008

(28.79)*** (7.5)*** (24.16)*** (9.61)***

Cash flow -0.0014 -5.5E-05 0.0016 -2.4E-05

(-0.47) (-1.32) (3.1)*** (-0.55)

Tangibility 0.0133 0.0871 0.0866 0.0340

(4.36)*** (21.22)*** (30.35)*** (9.41)***

Firm age -0.0006 -0.0008 -0.0003 -0.0012

(-20.28)*** (-18.24)*** (-15.2)*** (-24.61)***

Intercept 0.0849 0.0716 0.0475 0.0926

(53.8)*** (34.3)*** (25.21)*** (51.73)***

Industry dummies Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes

Number of observations 33,366 30,668 30,755 33,279

Adj.R^2 0.19 0.20 0.34 0.15

Table 4 Regressions of Capex on Repurchases and Substitution Hypothesis. The dependent variable is the ratio of Capex to Net Assets. All independent variables are defined in section on Data and descriptive statistics. Models 1–2 regress Capex in fiscal year t on net repurchase in year t. We separate the dataset into two subsamples by year 2001. Industry dummies are based on two-digit Standard Industrial Classification codes. T-Statistics are in parentheses. The t-statistics are based on heteroskedastic-consistent standard errors. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Independent variable Before 1992 (1) After 1992 (2)

Repurchases 0.0015 -0.0003

(0.86) (-2.53)**

Dividends -0.0527 -0.0001

(-4.59)*** (-0.5)

Log firm size 1.31E-06 1.52E-08

(5.72)*** (0.77)

Leverage 0.0203 -0.0001

(6.26)*** (-4.31)***

Market to book 0.0131 0.0008

(23.62)*** (12.17)***

Cash flow 0.0130 -4.7E-05

(4.66)*** (-1.39)

Tangibility -0.0067 0.0598

(-1.17) (22.11)***

Firm age -0.0013 -0.0006

(-18.99)*** (-22.66)***

Intercept 0.0830 0.0605

(16.77)*** (35.94)***

Industry dummies Yes Yes

Year dummies Yes Yes

Number of observations 19,545 44,489

Adj.R^2 0.11 0.24