Agency Theory

The agency problem between managers and shareholders can be resolved via paying high dividends. If retention is low, managers are necessary to increase additional equity capital to finance investment. Each fresh equity matter will expose the managers financing decision to providers of capital as like bankers, suppliers, investors and so on. Managers will so engage in activities such are consistent along with maximization of shareholders wealth with making full disclosure of their activities.

This is since they know the firm will be exposed to external parties during external borrowing. Thus, Agency costs will be reduced as the firm becomes self-regulating. Dividend policy will contain a beneficial effect on the value of the firm. This is since dividend policy can be used to decrease agency problem with decreasing agency costs. The theory implies about firms adopting high dividend payout ratio will contain a higher because of decreased agency costs.