Dividends as a Solution to Agency Cost and Opaqueness: Theory and Evidence

We develop a model that explains the use of dividends in continuous time as a means of reducing agency cost. Ideally firms are transparent and shareholders can costlessly monitor managers. However perfect transparency is not always possible. Managers of opaque firms are harder to monitor and are subject to greater agency costs than managers of firms that are transparent. Similar to previous models, dividends are a means of reducing agency cost by removing excess cash available to managers. Since shareholders can monitor firms that are transparent, dividends are only required for opaque firms. Dividend policy is reevaluated whenever shifts in opaqueness occur. This reevaluation provides a multiperiod explanation to dividends that is absent in prior literature. Our theory generates predictions that are tested and supported