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Dividend Policy, Agency Costs, and Earned Equity

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Author Info
Harry DeAngelo
Linda DeAngelo
Rene Stulz

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Abstract

Why do firms pay dividends? If they didn't their asset and capital structures would eventually become untenable as the earnings of successful firms outstrip their investment opportunities. Had they not paid dividends, the 25 largest long-standing 2002 dividend payers would have cash holdings of $1.8 trillion (51% of total assets), up from $160 billion (6% of assets), and $1.2 trillion in excess of their collective $600 billion in long-term debt. Their dividend payments prevented significant agency problems since the retention of earnings would have given managers command over an additional $1.6 trillion without access to better investment opportunities and with no additional monitoring. This logic suggests that firms with relatively high amounts of earned equity (retained earnings) are especially likely to pay dividends. Consistent with this view, the fraction of publicly traded industrial firms that pays dividends is high when the ratio of earned equity to total equity (total assets) is high, and falls with declines in this ratio, becoming near zero when a firm has little or no earned equity. We observe a highly significant relation between the decision to pay dividends and the ratio of earned equity to total equity or total assets,controlling for firm size, profitability, growth, leverage, cash balances, and dividend history. In our regressions, earned equity has an economically more important impact than does profitability or growth. Our evidence is consistent with the hypothesis that firms pay dividends to mitigate agency problems.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10599.

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Date of creation: Jul 2004
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Handle: RePEc:nbr:nberwo:10599

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Find related papers by JEL classification:
G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May. [Downloadable!] (restricted)
  2. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
  3. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June. [Downloadable!] (restricted)
  4. Feldstein, Martin & Green, Jerry, 1983. "Why Do Companies Pay Dividends?," American Economic Review, American Economic Association, vol. 73(1), pages 17-30, March. [Downloadable!] (restricted)
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  5. Shlomo Benartzi & Roni Michaely & Richard Thaler, 1997. "Do Changes in Dividends Signal the Future or the Past?," CRSP working papers 455, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October. [Downloadable!] (restricted)
  7. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April. [Downloadable!] (restricted)
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  8. Gustavo Grullon & Roni Michaely & Bhaskaran Swaminathan, 2002. "Are Dividend Changes a Sign of Firm Maturity?," Journal of Business, University of Chicago Press, vol. 75(3), pages 387-424, July. [Downloadable!]
  9. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nam, Jouahn & Wang, Jun & Zhang, Ge, 2004. "The impact of the dividend tax cut and managerial stock holdings on corporate dividend policy," Working Papers 2004-09, University of New Orleans, Department of Economics and Finance. [Downloadable!]
  2. Richard W. Kopcke, 2005. "The taxation of equity, dividends, and stock prices," Public Policy Discussion Paper 05-1, Federal Reserve Bank of Boston. [Downloadable!]
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This page was last updated on 2009-11-25.


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