Revised article published in Journal of Financial Economics vol. 87, no. 1 (January 2008): 200-226.
Movements in the value of corporate assets are justified by changes in expected future cash flow. The appropriate measure of cash flow for valuing assets is net payout, which is the sum of dividends, interest, and net repurchases of equity and debt. When discount rates are low and equity issuance is high, expected cash-flow growth is low because firms repurchase debt to offset equity issuance. A variance decomposition of the ratio of net payout reveals little transitory variation in discount rates that is not offset by common variation with expected cashflow growth.
Keywords: asset valuation, excess volatility, payout policy
JEL classification codes: G12, G32, G35