Payout Flexibility and Firm Innovation

This paper investigates how flexibility in payout decisions affects firm innovation. Firms that make payout mainly in the form of share repurchase have greater flexibility in making payouts compared to firms that make payout mainly in the form of dividends. Using a sample of 45,644 firm-year observations of 7,888 U.S. firms for the period 1987-2010, I show that firms with greater payout flexibility have higher levels of innovation and have better quality innovations. Using a Granger Causality framework, I show that firm innovation has no significant effect on payout flexibility while payout flexibility results in firm innovation. Results show that firms that make payout in the form of repurchase only, on an average, have 4.4% more patents granted compared to firms that make payout in the form of dividend only. The results are robust to whether I use the entire sample or a sub-sample of observations of firms with at least one patent granted during the sample period.