The Implication of Agency and Transaction Costs in the Determination Dividend Policy: Case of Listed Firms in Kenya

Abstract

This study investigates the implications of agency and transaction costs in the determination of the dividend policy with specific reference to listed firms in Kenya. It is based on Ro/efTs (1 ‘>82) Cost Minimization Model, w Inch predicts that the optimal target dividend payout ratio is observed at the level where transaction costs associated with raising external finance und agency costs ate minimized. The study analyzes a sample of 20 listed firms using panel data for a period of 6 years (1909 2004). Transaction cost is proxied by four variables namely growth defined as the annual rate of chungc in the total net assets of the firm; risk, measured as the volatility of the firms* daily sttick prices in each year; firm thinness, defined us the number of days the firm trades its shares on the stock exchange in a given year relative to the number ol days trading takes place on the stock exchange in the same year and finally liquidity is measured us turnover divided by market capitalization of the linn. Agency cost is pmxied by the percentage of shares owned by the public (who constitute individual Kenyan investors). Kenyan institutions (these include insurance companies, mutual funds and financial institutions) and foreigners (these include foreign nationals, institutions). Following the diagnostic tests, the random effects model is (bund to be the best lilted model. The results show that firms that experience an increase in the amount of the total net assets oiler lower dividend payouts as such growth rates require more funds to meet high investment expenditures. Secondly, linns whose shares are frequently traded on the stock exchange establish higher dividends since they can easily raise capital from the market at low cost resulting to higher ratio of retained earnings that can be paid as div idends. Subsequently, finns whose share prices arc highly volatile establish low dividends pay out as this implies possible mis pricing and higher underwriting lees when raising external finance. Lastly, the findings show that the higher the percentage of shares owned by the public. Kenyan institutions and foreign investors, the lower the dividends payout. Generally, the findings support the fact that agency and transaction costs arc key determinants of dividend pay out and that Finns determine the optimal dividend pay out ratio through time by minimizing both agency and transaction costs.