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Essays on dividend policy Bhattacharyya, Nalinaksha

Abstract

This model explains dividend policy as a component of a screening contract set up by an uninformed principal. Our model assumes that the manager wants to maximize his net wealth and the principal recognizes this and sets up a screening contract to utilize the skill of the agent in the productive enterprise.This model deals simultaneously with moral hazard and hidden information. We model hidden information in two ways-hidden information about the productivity of agent and hidden information about the initial cash endowment of the agent. We find that when hidden information is about the productivity of the agent then, contrary to the findings of the dividend models based on the signaling paradigm, dividend - conditional on cash availability - bears an inverse relationship to managerial type. That is, for a given level of available cash, the x lower type manager declares a higher dividend than that declared by a manager with higher productivity. Still this particular model can be used to explain many of the empirical findings obtained by other researchers. An interesting corollary of our model is that with costly effort and differences in productivity, the relationship between dividend and managerial type flips from being monotone increasing to monotone decreasing; this corollary extends the result obtained by Miller and Rock (1985). Another interesting implication of this dissertation is that dividends can be shown to be relevant in the presence of moral hazard and hidden information, even when the agency contract is chosen optimally . When the hidden information is about the initial cash endowment of the agent then however we find that the agent with greater cash endowment declares higher dividend. We can therefore see that the nature of the hidden information plays a critical role in determining the relationship between dividends and agent type. When cash available is common knowledge and the asymmetric information is about the productivity of agent then higher dividend -conditioned on cash availability- is an indication of lower agent type. However when productivity of agent is common knowledge and the asymmetric information is about the initial cash endowment of the-agent then higher dividend is an indication of higher agent type. We may note here that the outcome of the model in the second case is in line with the outcome of the signalling models and the free cash flow conjectures by Easterbrook (1984) and Jensen(1986).

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