The Cash-Flow Permanence and the Choice between Dividends and Stock Repurchases

Firms can use dividends and/or share repurchases to distribute cash to shareholders. Jagannathan, Stephens, and Weisbach (2000) argue that managers tend to use dividends to pay out permanent cash flows and repurchases to pay out temporary cash flows. This paper examines Korean firms’ decisions on their choices between paying out cash flows in the form of dividends or share repurchases. We focus on the permanence of cash flows. To complete this analysis, we decompose cash flows into a transitory component and a permanent one of each firm, employing the approach of Beveridge and Nelson (1981). We find that higher permanent cash flows increase the probability of a dividend increase, while higher temporary cash flows increase the probability of repurchases. And Korean firms tend to choose both dividend change and repurchases when temporary cash flows increase, rather than to choose only repurchases without dividend change. These empirical results show that Korean firms take into consideration of permanence of cash flows in the choice of their payout methods.