Control of Dividends, Capital Subscriptions, and Physical Inventories

Business organizations are faced with the financial and physical task of managing interrelated flows of material and cash. Material needs capital, and on the other hand, when finished goods are sold, they contribute to cash reserves. In this paper, we present and study a dynamic model in which inventory and financial decisions are made simultaneously and interact directly with each other in the presence of demand uncertainty and financial constraints. The criterion is to maximize the expected present value of dividends net of capital subscriptions. We establish conditions which imply that the optimal values of dividends, capital subscriptions, material procurement, and short term borrowing are nondecreasing functions of the levels of inventory and retained earnings. We establish that the optimal policy is myopic and explicitly characterized for a special and important case where both inventory costs and default penalties are linear. As a consequence, the optimal base-stock inventory level should be lower in a dividend-maximizing firm than in a profit-maximizing firm