| This study investigates the role of agency costs as a possible determinant of dividend payout over time and under changing conditions. Agency theory posits that by distributing resources in the form of cash dividends, the internally generated cash flows are no longer sufficient to satisfy the needs of the firm. Therefore, managers must subject themselves to the scrutiny of capital markets in order to attract new funds. Hence, the payment of dividends induces managers to reduce agency costs.;The present study incorporates two market imperfections, i.e., transaction costs associated with external financing and agency costs which are present in the ownership structure of the firm. A model of optimum dividend payout, which assumes that increased dividends lower agency costs but raise transaction costs for external financing, is presented. Optimum dividend payment is determined by minimizing the sum of these two costs at a given point of time.;A time-series cross-sectional test of the suggested model is performed on a sample of industrial companies (341 unregulated and 59 regulated firms) over the 18 year period 1972-1989. In effect, this study moves away from testing behavior of the firm on an "event study" basis by looking instead at the time-series cross-sectional behavior of firms.;The empirical evidence in this study is consistent with the hypotheses presented, and the coefficients of the model variables are significant in the predicted directions. These empirical results indicate that a trade-off between transaction costs and agency costs is likely to determine a firm's optimum dividend payout ratio, even without consideration of the tax implications. This relationship is stable over time and under changing conditions. Hence, this study validates empirically the agency theory explanation of dividend policy at the firm level.;On the academic level, this study contributes to solving the dividend puzzle. On the practical level, this study should be of interest to firm directors, management, and stockholders as a device to solve the agency problem and minimize agency costs. It should also be of interest to investors and security analysts. |
