Which of the following statements concerning payout policy is incorrect?

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BlackTom AI · Accepted Answer

Question restatement: Which of the following statements concerning payout policy is incorrect?
Option 1: Retaining excess cash can lead managers to fund money-losing projects or acquisitions. This is a commonly discussed consequence of the free cash flow problem: when firms hoard cash, managers may pursue projects that destroy value or engage in acquisitions that are not value-maximizing, so this statement is generally considered true rather than incorrect.
Option 2: Retaining excess cash can be useful to avert financial distress to save on equity issuance costs. This reflects the precautionary motive for holding cash, which can help avoid costly emergency financing or equity issuances during downturns; thus this statement is typically true.
Option 3: Share repurchases affect the percentage equity ownership of shareholders who do not sell. Buybacks reduce the number of shares outstanding, so continuing holders’ ownership percentages can rise if they do not participate in the repurchase; this statement is true.
Option 4: Large dividend payments help reduce a firm’s debt-to-value ratio, but share repurchases have the opposite effect. Here, the claim mixes effects in a misleading way: paying dividends drains cash and reduces equity, but debt-to-value (often debt to enterprise value) is not directly reduced by dividends, and repurchases do not categorically have the opposite effect; leverage changes depend on financing choices and market valuation. In many payout policy discussions, neither large dividends nor buybacks guarantee a reduction in the debt-to-value ratio, and buybacks can reduce equity and potentially alter leverage either way depending on how they are financed. This makes the statement as stated not accurate for payout policy guidance, rendering it incorrect.

In summary, options 1, 2, and 3 describe well-established aspects or consequences of payout policy, while option 4 presents an incorrect or misleading characterization of how dividends and share repurchases interact with debt-to-value and leverage.

COMM_V 370 101-108 2025W1 COMM 370 2025W1 - Practice Final

Which of the following statements concerning payout policy is incorrect?

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