Integrating profitability prospects and cash management

Résumé

We develop a bi-dimensional dynamic model of corporate cash management in which shareholders learn about a firm's profitability and weigh the costs and benefits of holding cash. We explicitly characterize the optimal payout policy. We explain how the evolution of the strength of shareholders' beliefs about profitability and changes in corporate cash management are intertwined. The model predicts that both cash target levels and target dividend payout ratios are increasing in profitability prospects. This yields novel insights into the relationship between profitability prospects, precautionary cash savings, dividend policy and the dynamics of firm value.