Debt and Dividend Decisions: Stock vs. Non-stock Firms

Document Type

Article

Publication Date

2012

Abstract

This study tests the trade-off and pecking order theories about the debt and dividend decisions for stock and non-stock firms. The decision to finance investments with debt or equity determines the firm's capital structure. The trade-off theory posits an optimal balance of debt and equity, motivating the form to use debt until its cost exceeds issuing equity thus deriving the firm's optimal capital structure. Meanwhile, the pecking order theorem contends the firm should use internal funds first, then debt, and equity as a last resort. Both theories have the same fundamentals for the payout of dividends. More profitable firms with less risk and debt should pay our more dividends. Unlike previous work, this study examines both stock and non-stock firms. Capital credits or dividends are the accumulated profits (or retained earnings) the not-for-profit cooperatives payout to their owners who are also the firms' customers. This study's non-stock sample consists of over 800 rural electric cooperatives (RECs) while the stock companies sample includes 1700 firms followed by Value Line Investment Survey. For both samples, this study analyzes financial data using OLS regression to test the effects of selected financial variables on the debt and dividend decisions. Debt and dividend decisions for the non-stock firms support the trade-off hypothesis. For the stock firms analyzed in this study, the dividend decisions support the trade-off theory while the debt decisions follow the pecking order hypothesis.

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