CHAPTER II LITERATURE REVIEW
2.1 Agency Theory
According to Brigham and Houston 2006, agency theory is a condition which manager is authorized by the owner of the company to make decision,
where it will create potential conflict of interest. Agency relationship occurs when one or more individuals who are referred as principals hire individuals from other
organizations, which is referred as agents, to perform services and delegate the authority to make decisions for agents. Managers and shareholders do not always
have the same goals, so it has potential conflicts of interest. Agency theory, the analysis of such conflicts, is now a major part of the
economics literature. The payout of cash to shareholders creates major conflicts that have received little attention. Payouts to shareholders reduce the resources
under managers’ control, thereby reducing managers’ power, and making it more likely they will incur the monitoring of the capital markets which occurs when the
firm must obtain new capital. Financing projects internally avoids this monitoring and the possibility the funds will be unavailable or available only at high explicit
prices Jansen, 1986. Managers have incentives to cause their firms to grow beyond the optimal
size. Growth increases managers’ power by increasing the resources under their control. It is also associated with increases in managers’ compensation, because
changes in compensation are positively related to the growth in sales. The
tendency of firms to reward middle managers through promotion rather than year- to-year bonuses also creates a strong organizational bias toward growth to supply
the new positions that such promotion-based reward systems require Baker in Jansen, 1986.
There are several alternatives to reduce agency cost. firstly, management increase company stock ownership so manager will feel the direct benefits of the
decisions taken and if there are any loss that arising, it is a consequence of making wrong decision. Stock ownership by management is an incentive for managers to
improve the companys performance. Secondly, using the dividend payout ratio DPR, thus not available pretty much free cash flow, so that management did not
have the opportunity to invest that do not comply with the wishes of shareholders. Thirdly, institutional investors as monitoring agents stated that distribution of
shares among shareholders from outside the institutional investors and shareholder dispersion can reduce agency cost. This is because ownership
represents a source of power that can be used to support or oppose the presence of management.
2.2 Dividend Theory
