What are the effects of Information Asymmetry and Agency Costs on Dividend Policy?

What is Information Asymmetry?

In an organization, there are many layers of managerial positions and the managers have information of different aspects about the business model and operations, and financial issues. The shareholders may not be aware of all the situations in operations as well as the finance segments of the business. This lack of knowledge that exists between the managers and shareholders is known as information asymmetry.

What are Agency Costs?

Information asymmetry can lead to a great deal of complexity in running a business organization.

• There may be conflicts between the managers and shareholders in running a business and managing it.

• Managers may want to get higher commissions for their contribution towards making the company successful and they may also hide some aspects of the business to gain advantage in terms of finances of the firm.

• These problems that arise between managers and shareholders are known as agency problems and all organizations having managerial staff face more or less of these problems.

• Managing agency problems require some costs which are known as agency costs in the financial terms.

• Agencies must try to minimize these agency costs so that the maximum of funds can be distributed among shareholders.

Effects of Information Asymmetry and Agency Costs

There are various ways in which the management of a firm is guided and kept motivated to avoid the agency costs. Offering ownership with shares and stock, increasing the remunerations, and paying more attention to the contributors are some of the ways to reduce agency costs.

• Companies usually try to diminish the information asymmetry levels to the lowest to run the business without any trouble, but it is nearly impossible to remove information asymmetry completely for the businesses. The organizations therefore try to document and keep an eye on management activity to the fullest of its extent.

• Agency problems may also be trickier when the organization takes out a loan to run its business. The company must pay the loans first before it pays out the dividends. However, the shareholders tend to receive the money as soon as possible and the management may fall into trouble while choosing the first preference to allocate the funds to.

• Agency problems can lead to losses in operations and it can derail the business process when not monitored carefully. Shareholders therefore monitor the businesses they have invested in carefully to gauge the various agency costs and problems that may arise from time to time.

Conclusion

It is a norm that companies try to reduce their agency problems in order to improve their business operations and stay profitable in the long run. In the context of dividend policy, shareholders tend to receive dividends earlier than the lenders who have offered a loan to the firm.