The dividend policies of all‐equity firms: A direct test of the free cash flow theory

Anup Agrawal · Narayanan Jayaraman B

204 citations0/0 files storedManagerial and Decision Economics

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Abstract

Abstract This paper finds support for Jensen's (1986) hypothesis that dividends and debt are substitute mechanisms for controlling the agency costs of free cash flow. We find that dividend payout ratios of a sample of all‐equity firms are significantly higher than those of a control group of levered firms. Further, within the group of all‐equity firms, firms with lower managerial holdings have higher payout ratios. These results hold after controlling for free cash flow and growth rates. Overall, our evidence suggests that dividends and managerial ownership are substitute mechanisms for reducing agency costs in all‐equity firms.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1996Agency costs of free cash flow, corporate finance, and takeovers 1961Dividend Policy, Growth, and the Valuation of Shares 1985The Structure of Corporate Ownership: Causes and Consequences 1956DISTRIBUTION OF INCOMES OF CORPORATIONS AMONG DIVIDENDS, RETAINED EARNINGS AND TAXES 1984Two Agency-Cost Explanations of Dividends 1979Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy

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