The Impact of Ownership Structure on Corporate Financial Policies

Abstract

Agency theory recognizes that because common stockholders are dispersed and hold diversified portfolios, they delegate financial and other decision making to corporate managers. However, managers may have personal goals that compete with shareholder's wealth maximization, and such conflicts of interest are addressed by agency theory. Equity agency cost are incurred when managers do not attempt to maximize firm value; And stockholders incur costs to monitor the managers and influence their action. Agency theory suggests several ways to mitigate equity agency cost. Among those mechanisms, financial policies in the form of debt and dividends may reduce equity agency costs by "bonding" the free cash flow. In many agency studies, ownership structure of the firm in the form of insider ownership, institutional ownership, stockholder dispersion can also considered as determinants of equity agency costs. Extent literatures about agency theory suggest substitutability and simultaneous determination ofseveral ofthe agency-conflict-reducing mechanisms. Extant literatures about agency theory suggest links between financial policy and ownership structure of the firm. Studies of ownership structure and financial policy assume that any causality among these choices runs from ownership structure to financial policy. This research tries to examine the impact ofownership structure on corporate debt and dividend policies as well as the substitutability between these two financial policies in Indonesia manufacturing firms. This research finds that insider ownership has negative but insignificant impact on leverage ratio, while both institutional ownership and stockholder dispersion have negative and significant impact on leverage ratio. This research also finds that insider ownership has a positive and significant impact on dividend payout ratio, while both institutional ownership and stockholder dispersion have negative and insignificant coefficient. Finally, this research finds that there is an interrelationship between leverage ratio and dividend payout ratio, representing substitutability between the two mechanisms.