Industry characteristics, agency theory, and the interaction of capital structure and dividend policy

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Virginia Tech

The literature on agency theory has generally modelled and tested the firm’s dividend and capital structure decisions separately. In this dissertation, a model is developed based on agency cost considerations and dividends as a means of controlling equity agency costs, which simultaneously determines the optimal capital structure and payout rate for firms. However, to the extent that alternative, non-dividend mechanisms exist across industries and industry groups that may either diminish or nullify the effect of dividends in controlling equity agency costs, simultaneity is not predicted to be universal but a function of industry characteristics. This central hypothesis is tested on three industry groups: industrial firms, banks and electric utilities. Banks and utilities are regulated. Industrials are not regulated but are subject to other equity agency cost controlling mechanisms like the threat of takeover and incentive-based compensation packages. As hypothesized, the results for industrials show no simultaneity in the subsample where these other mechanisms are present, and simultaneity in the subsample where dividends are the dominant mechanism. For banks and utilities no simultaneity is found since regulation, through its effect on the debt agency cost curve of firms in these industries effectively precludes its occurrence.