Impact of Dividend Policy on Capital Structure

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Dissertation AN EMPIRICAL STUDY ON IMPACT OF DIVIDEND POLICY ON CAPITAL STRUCTURE (A report submitted towards the partial fulfillment of the requirement of the two years full-time Post Graduate Diploma in Management.) DECLARATION I, student of Post Graduate Diploma in Management from hereby declare that I have completed dissertation on “IMPACT OF DIVIDEND POLICY ON CAPITAL STRUCTURE ” a part of the course requirement. I further declare that the information presented in this project is true and original to the best of my knowledge. Acknowledgement It gives me immense pleasure to report successful completion of my dissertation entitled “IMPACT OF DIVIDEND POLICY ON CAPITAL STRUCTURE” It is my great privilege…show more content…
Information asymmetry between agents (managers) and principals (outside shareholders) may also lead to agency cost (Jensen and Meckling, 1976). One of the mechanisms of reducing expropriation of outside shareholders by agents is high payout. High payout will result in reduction of free cash flow available to managers and this restricts the empire building efforts of managers. The presence of information asymmetry may also mean that managers need to signal their ability to generate higher earnings in future with the help of high dividend payouts (Bhattacharya, 1979, John and Williams 1985, and Miller and Rock, 1985). However, the credibility of signals depends on the cost of signaling – the cost being loss of financial flexibility. High payout results in reduction of free cash flow when in fact the firm needs more funds to pursue high growth opportunities. Rozeff (1994) models payout ratios as a function of three factors: flotation costs of external funding, agency cost of outside ownership and financing constraints as a result of higher operating and financial leverage5.To summarize, several theories have been proposed in explaining why companies pay dividends6. While many earlier studies point out the tax-preference theory, more recent studies emphasize signaling and agency Cost rationale of dividend payments. However, the dividend puzzle is yet unresolved and the words of Fischer Black (Black 1976) may well apply in today’s context:
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