discusses the distribution of retained earnings as a choice between dividends, internal investments, and stock repurchases. The authors assert that management should invest in all proposed capital projects that exceed the firm’s marginal cost of capital, as depicted by the Investment Opportunity Schedule. Then, any left-over retained earnings should be distributed to shareholders, per the residual theory of dividends, or used to purchase the firm’s stock to reduce dilution of ownership.
However, in the real world, management often decides to do neither. They simply “bank” retained earnings in the form of a very large cushion of cash on the balance sheet. What are the pros and cons of management doing this? Please bring some textbook concepts into your comments, such as signaling and asymmetric information (and the agency problem, from an earlier chapter). I suggest that you Google “Apple Corporation cash” to get a view of additional implications involved when management simply holds onto retained earnings passively.
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