Agency Costs and Dividend Policy: A Review of Theories and Empirical Evidence

The research on dividend policy, subsequent to the irrelevance theory presented by Miller and Modigliani [1961], has been concentrated around market imperfections to contradict the notion that market value of a company is determined by its investment policy. Presence of conflict of interest between managers (insiders) and shareholders (outsiders) is one such major market imperfection which occasions agency problems. Objective of this paper is to provide an overview and synthesis of some important theories on agency problems and their impact on dividend policy of a firm and present important empirical studies conducted in the area. Mixed results were observed for use of dividends as a tool to reduce agency cost and enhance market value of firm. Further empirical studies can be carried out, to examine the impact of recently legislated investor protection reforms and their impact on reduction in agency costs.