Agency Cost of Free Cash Flow, Corporate Finance, and Takeovers

@article{Jensen1986AgencyCO,
  title={Agency Cost of Free Cash Flow, Corporate Finance, and Takeovers},
  author={Michael C. Jensen},
  journal={Industrial Organization \& Regulation eJournal},
  year={1986}
}
  • M. C. Jensen
  • Published 1 May 1986
  • Business, Economics
  • Industrial Organization & Regulation eJournal
The interests and incentives of managers and shareholders conflict over such issues as the optimal size of the firm and the payment of cash to shareholders. These conflicts are especially severe in firms with large free cash flows—more cash than profitable investment opportunities. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why “diversification” programs are more likely to generate losses… 
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References

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A model of optimal dividend payout is presented in which increased dividends lower agency costs but raise the transactions cost of external financing. The optimal dividend payout ratio minimizes the…
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