Dividend Policy in the Perspective of Agency Theory: The Role of Earnings Management, IOS, and Solvency

Abstract

This study aims to explore the role of Agency Theory in explaining dividend policy by considering internal firm factors such as earnings management, investment opportunity set (IOS), and solvency. Agency Theory explains that agency conflicts between managers and shareholders may generate agency costs, which can be mitigated through dividend policy. This study employs a literature review approach by analyzing academic articles published in both national and international. The findings indicate that dividend policy serves as an important mechanism to reduce agency conflicts by limiting free cash flow in the hands of managers while also providing positive signals to shareholders. The literature highlights that earnings management has a complex relationship with dividend policy; on the one hand, it may distort the basis for dividend distribution, but dividends can also constrain earnings manipulation. IOS generally reduces dividend payouts as firms prefer to retain earnings for investment, although in certain contexts dividends are also used as a signaling tool for growth prospects. Meanwhile, solvency shows varying effects depending on financial conditions and industry characteristics. Overall, this study confirms that dividend policy is not a stand-alone decision but rather the outcome of the interaction between Agency Theory, internal firm factors, and governance mechanisms. The study contributes theoretically by reinforcing the conceptual understanding of dividends as a governance instrument, and provides practical implications for managers, investors, and regulators in formulating effective financial strategies.