Q4) Suppose you decide to make a dividend payout ratio model using the Ageney Th
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Q4) Suppose you decide to make a dividend payout ratio model using the Ageney Theory for publicly listed companies operating within weak regulation countries A) What are the expected signs for "Ownership concentration" and " proxies for measuring the agency problems? ree cash flow" as using B) Suppose you also found that the "Leverage", "Profitability", "Growth opportunities", and "Risk" variables can affect the companies' dividend policies. What are your expectations about the above mentioned variables signs? Why? C) How the expected variables signs in Part B will be changed if the companies operating withir strong regulation countries?Explanation / Answer
A.
The Central idea on which the model rests is that the optimal payout ratio is at the level where the sum of these two type costs is minimized i.e. agency cost and transaction cost. The model captures agency costs with two proxies, First, the fraction of the firm owned by insiders,is a proxy for insider ownership and is expected to be negatively related to the target payout ratio. Second, the natural logarithm of the number of outside shareholders is a proxy for ownership dispersion. It is expected to be positively related to the target payout ratio because the greater the dispersion, the more severe is the collective action problem of monitoring. The Cost minimization model further by considering conflicts between the firm and its non equity shareholders and by introducing free cash flow as an additional agency variable.
B.
The Agency theory of dividend in general , and the cost minimization model in perticular, appear to offer good description of how dividend policies are determined.The variables in the original cost minimisation model remain significant with consistently signed estimated coefficients, the agency cost variable, ownership dispersion, is consistently positively related to the firm’s dividend policy, while the transaction cost variable, risk, is consistently negatively related to the firm’s dividend policy. The other transaction cost proxies, the growth variables, are also mainly significant and negatively related to the firm’s dividend policy. The profitability variable is positively relates to the dividend policies.
c. In strong regulated country, The first proxy, i.e. Leaverage is The linear relation between this variable and DIVIDENDPAYOUT can in the first place be negative. Debt financing comes with additional external monitoring. Due to this there is less need to use dividends as a mechanism to reduce agency problems.
The seccond proxy, profitability, profitability is another factor that affects the decision to pay dividends. Like larger firms, more profitable firms are more likely to pay dividends.When the profit increases in a firm, it is possible that the amount of free cash flow also increases. Therfore, the expected coefficient for will be positive.
A third control variable is GROWTH. Firms in industries which have more opportunities for growth or have higher risk are expected to have a lower dividend payout ratio (Manos, 2001). Firms establish lower dividend payout ratios when they are experiencing or anticipate experiencing higher revenue growth, because this growth entails higher investment expenditures (Rozeff, 1982). It is expected that growth firms need their cash for investments. They can not afford to pay out dividends, so will have a negative coefficient.
The last control variable is Risk, some industries are subject to significant volatility in their prices, and thus earnings, while other may be growing at different rates compared to the economy as a whole. It is hypothesized that such differences should have an impact on the dividend payour policy decision. Manos (2001) have investigated this hypothesis for Indian industries in 1990 and 1994. He concluded that the payout ratios are indeed different across industries as well as within the same industry over time. Firms in different industries operate under different set of regulations and often face different levels of risk and growth potential. The industry dummy, , is included to test for a difference in the intercept when the firm belongs to specific industries. No direction can be given to this control variable.
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