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dividend choices as follows: For highgrowth firms, the underinvestment problem caused by heavy debt financing and the flotation costs associated with high dividends make both policies potentially very costly. But, for well-established companies with limited growth opportunities (and here the argument goes beyond Myersâ 1977 paper), high leverage and dividends can actually have major benefits by controlling a managerial tendency to âoverinvestâ known as the free cash flow problem. In our second article, âFinancial Policy As A Catalyst For Organizational Change,â Harvard Business Schoolâs Karen Wruck presents a case study of Sealed Air Corporationâs leveraged restructuring that illustrates both the free cash flow problem and the potential role of debt financing in correcting it. The story in brief is this: Although Sealed Air was producing steady increases in EPS throughout the â80s, its operating performance as measured by other indicators (operating margins, working capital, turnover ratios, etc.) was mediocre and its stock price was underperforming market averages. With $55 million in cash and marketable securities, but only $33 million in total debt and no promising investment opportunities, Sealed Air was generating far more cash than it could profitably reinvest in the firm. And though patents on some of
Journal of Applied Corporate Finance – Wiley
Published: Jan 1, 1995
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