TARGETING FIXED REINVESTMENT RATE WITH NONLINEAR MECHANISM: A “STRANGE” PATH TO FINANCIAL DISTRESS

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Abstract

Governance arrangement between shareholders, debtholders and managers fix the reinvestment ratio of profits. Residual earnings will appear as excess cash flow to disgorge in dividend disbursements or share repurchases. However, financial crisis stimulates corporation to express highest aversion both to overinvestment or underinvestment, probably in an identical degree. Besides, dissuasion to commit fraud pushes ownership to select a strong dynamical mechanism adjusting held earnings to the preferred reinvestment rate. Focus? Immediate disbursement of free cash flows. This paper shows that self-imposed discipline targeting fixed reinvestment rate under nonlinear adjustment speed can inject itself a “strange” dynamics to the firm, leading to critical losses and a bankruptcy threat. However, one way to reduce this instability is determining carefully the “normal” cash flow which does not trigger the payout.

Keywords: Self-Imposed Discipline, Capitalization, Dynamical Model

How to cite this paper: Bouali, S. (2009). Targeting fixed reinvestment rate with nonlinear mechanism: a “strange” path to financial distress. Corporate Ownership & Control, 7(2-2), 311-318. https://doi.org/10.22495/cocv7i2c2p6