What is the relation between financial flexibility and dividend smoothing?

This paper investigates the relation between financial flexibility and dividend smoothing policies. We use two proxies for financial flexibility; we measure levels of unused debt capacity and capital structure adjustment speeds. We find a nonlinear relation between unused debt capacity and dividend smoothing. For firms with high levels of unused debt capacity, this relation is positive. However, we find a negative effect for firms with low levels of unused debt capacity. Additionally, we show a positive relation between capital structure adjustment speeds and dividend smoothing. We find that firms absorb shocks to net income by changing their capital structure, and this change enables dividend smoothing. The effects we document are stronger for positive changes to a firm’s net income.