Control of Dividends, Capital Subscriptions, and Physical Inventories

Manufacturers manage interrelated flows of material and cash. Material needs capital, and sales contribute cash. Therefore, it may be beneficial to coordinate operational and financial decisions. We study a dynamic model of coordination in an equity‐financed firm in which inventory and financial decisions interact in the presence of demand uncertainty, financial constraints, and a risk of default. The criterion is to maximize the expected present value of dividends net of capital subscriptions. The optimal target inventory level and financial decision variables are nondecreasing functions of the levels of inventory and retained earnings. Some important attributes of an optimal policy remain the same regardless of whether default precipitates Chapter 7 or Chapter 11 bankruptcy. The optimal policy is myopic, and if pertinent cost functions are piecewise linear, it is characterized with simple formulas. We show that the methods of inventory theory are useful in analyzing models of operational and financial coordination.