Dividend and Investment Decisions of Indian Corporate Firms Under Cash Flow Uncertainty

The Miller–Modigliani theory proposed that in perfect capital market, dividend and investment decisions are mutually separable, which is commonly known as the “separation principle.” On the basis of this theory, this article tries to investigate the dividend–investment relationship from a new perspective by introducing the cash flow uncertainty. This cash flow uncertainty is measured by cash flow shortfall and cash flow volatility. Using firm-specific data on relevant variables of the BSE-listed firms from 2001 to 2015, this article tries to explore the instruments which help to resolve cash flow uncertainty of the firm. Classifying firms into quintiles and dividing them into positive and negative shortfalls on the basis of both the measures of cash flow uncertainty, our main results show that firms mainly use external financing to resolve cash flow uncertainty. However, cash drawdown plays a trivial role in mitigating shortfalls. Moreover, applying the linear panel data estimation, the relationship between dividend and investment is explored for firms having a positive cash flow shortfall, using both measures of cash flow uncertainty. Our results reported that firm’s investment decision has no impact on dividend decision and vice versa. Hence, dividend and investment choices are made independently under cash flow uncertainty. Thus, our results support the “separation principle” under cash flow uncertainty.