Dividend Payout Policy this file 555 2271 1 PB

Jurnal Administrasi Bisnis JAB|Vol. 13 No. 2 August 2014| administrasibisnis.studentjournal.ub.ac.id 3 e. the absence of information asymmetries – what management knows about the future is not significantly different from what investors know. Barclay, et al., 1995 The assumption of Dividend Irrelevance Theory is based on an efficient capital market. In an efficient market, the shift of ownership is created by the change in dividend policy that is conducted in fair conditions Brealy et al., 2007, which means that dividend policy does not affect the overall value of stockholders’ equity or in other words, there is no party who is advantaged or disadvantaged. Under Dividend Irrelevance Theory, financial leverage and dividend decisions are likely to be unimportant since they have no impact on firm value Ross et al., 2008. The manager’s decisions either to raise or to lower the current dividend do not affect the current value of the company. 2. The Free Cash Flow Hypothesis Free cash flow refers to the cash that is not retained and reinvested in the fixed assets or working capital so that it is available for the investors Brealy et al., 2007. It is the cash flow available for shareholders after funding profitable investments for the sustainability of a business. Therefore, free cash flow is the cash flow in excess of the cash required to fund profitable capital projects. The mature firms that are able to generate enough income to cover their investment financing needs through their operations should spend their free cash flows in the form of dividend Jensen, 1986 as cited by Ardestani et al., 2013. According to the free cash flow hypothesis, an increase in dividends should benefit the stockholders by reducing the ability of managers to pursue wasteful activities, since dividend payment reduces the free cash flow. Furthermore, the free cash flow also implies that debt reduces free cash flow because the firm must make interest and principal payments. 3. Agency Cost Theory According to the free cash flow model, finance available after financing all positive net present value projects can result in conflicts of interest between managers and shareholders Jensen, as cited in Abor and Bokpin, 2010. The conflict of interest between managers and stockholders is the result of each party’s tendency to give priority for their personal interest. Bondholders would like the stockholders to leave as much cash as possible in the firm so that this cash would be available to pay the bondholders during times of financial distress. Stockholders would like to keep the extra cash for themselves. Meanwhile, managers may pay dividends simply to keep the cash away from the bondholders. Managers may also pursue their personal interest at the expense of stockholders especially when the corporation has plenty of free cash flow. The agency cost refers to the management’s intention to invest in negative Net Present Value projects; however dividend payout can eliminate this problem by controlling the cash available to managers Jensen, 1986 as cited by Ardestani et al., 2013. According to the free cash flow model, firms with higher level of cash flow should have either higher dividend payout or higher leverage in order to minimize the agency cost. Therefore, dividend can serve as a way to reduce agency costs. By paying dividends equal to the amount of surplus cash flow, a firm can reduce management’s ability to squander the firm’s resources.

B. Dividend Payout Policy

Dividend policy as defined by Brealy et al. 2007 is the trade-off between retaining earnings and paying out cash, and issuing new shares on the other hand. It implies that dividend payout policy involves the decisions to pay out earnings to stockholders or to retain them for reinvestment in the company. The dividend payout policy is at the discretion of the board of directors. Deciding the amount of earnings to be paid out as dividends is a crucial task for corporate financial manager. This policy is very important since the dividend decisions determine the amount of fund that flows to investors as dividends and the amount of fund that is retained by the firm for reinvestment. Brealy et al. 2007 stated that a company’s decisions concerning dividends are often mixed up with investment and financing decisions. They explained that dividends can be either a by-product of the firm’s capital budgeting or a by-product of the borrowing decision. Dividend is considered to be a by- product of the firm’s capital budgeting when firm pays low dividends because management is optimistic about the firm’s future and wishes to retain earnings for expansion. Meanwhile, dividend is considered to be a by- Jurnal Administrasi Bisnis JAB|Vol. 13 No. 2 August 2014| administrasibisnis.studentjournal.ub.ac.id 4 Companies always have the tendency to pursue a relatively stable dividend policy. In fact, profits of firms fluctuate as the level of business activity changes. Therefore, in order to pursue the relatively stable dividend policy, companies maintain a target dividend per share. When earnings are increased, companies will not increase the dividend per share until it is clear that the increased earnings is sustainable. Once they increase the dividend per share, they will maintain it and take efforts to bring the dividend ratio into higher new level.

C. Investment Opportunity Set IOS