Abstract:
The theory of agency originates from the distinction of the company ownership with management resulting in the existence of conflict of interest between the agent and the principal. The larger free cashflow owned in certain company, the larger potency of agency problems will emerge and also the larger dividend will be required to control them. It means that, the larger portion of free cash flow must be distributed as dividend for shareholder in order to decrease the occurrence of agency problems emerged from such free cash flow . The conflict of interest will emerge between the shareholder and managers on the matter of dividend payment policy when certain organization gains substantive free cash flow. The problem is how to motivate the manager to be able to pay such cash flow rather than whether investing on the project with level below the cost of capital or causing inefficiency in the organization. These findings imply that the debt was used not only as a tool to limit the agency problems of free cash flow between manager(s) and the sharehoholder(s), but also between the manager and creditors. However, when managerial ownership got increased, the debt would be
decreased since the large debt will increase the cost of bankruptcy. The correlation of free cash flow with maturity can be stated: If the investor does want the manager to increase the value of organization, the dividend should be paid if only the company doesn't have profitable Investment project anymore (positive net
present value). Both free cash flow and maturity already explained the signaling model by providing clarification, theoretically and empirically, about one of central issues that becomes the limitation of such signaling model.
