In “Capital Structure, Payout Policy, and Financial Flexibility”, the DeAngelos discuss policies such as cash balances, amounts of leverage, equity payouts, capital infusions, and capital structure rebalancing. They believe mature, FCF-generating firms maintain moderate cash balances, low leverage, high equity payouts, preserve issuance of debt, and if they do issue debt restructure when conditions permit. The main reasons behind these positions are so companies can maintain a strategy that both controls agency problems and builds maximal financial flexibility.
The DeAngelos argue companies should maintain moderate cash balances while M&M suggest high balances are required to maximize financial flexibility. M&M views cash as the answer for managers to take advantage of positive NPV projects without raising capital. The DeAngelos believe moderate balances will provide flexibility and control agency costs by limiting the assets subject to managerial decisions.
Other authors view high leverage as a good thing. Jensen sees high leverage as a way to force cash disgorgement, while the DeAngelos view low leverage as a way to preserve debt capacity for possible future use. Critics argue high leverage has legal advantages as a cash disgorgement mechanism, but the DeAngelos find high leverage restricts company’s flexibility. Firms may be financially unable to handle unanticipated earnings shortfalls or new investment opportunities if they are highly levered.
To illustrate some of DeAngelos’ points, we can look at the three automakers current situation as they have maximized their debt, have other payout commitments (UAW), and are running out of cash. In other words, they have reduced their financial flexibility DeAngelos describe and now face possible bankruptcy. The DeAngelos instead suggest the optimal financial policy should be low leverage with substantial ongoing equity payouts.
Equity payouts and capital infusions is where the DeAngelos differ...