About M & M Theory

Topics: Economics, Cost, Dividend Pages: 1 (342 words) Published: February 21, 2013
about M & M theorem
M & M theorem about capital market is based on the assumption that there is no conflict of interests between managers and shareholders. However, in real world, the assumption is not always true, because a company’s agents (managers) and principals (shareholders) belong to different groups and have their own personal interest. They have their own demand to maximize their interests. Therefore, it is very important those explored study on how to protect principal's interests from agents' behavior or decisions.Agency theory comes from the literature name Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, written by Jensen and Meckling in 1976. It relaxes some of the hypothesis of the M&M theory on the basis of development. In this literature, Jensen and Meckling discussed agency costs, analyzed two types of agency cost from the expenditure and ownership structure view. They provided stronger explanation on dividend existence and the dividend payment mode. Then their viewpoint becomes the mainstream view of modern dividends theoretical study. Jensen and Meckling define that there is an agency relationship as a contract between the principals and the agent. Agents pursue their own utility maximization, so, from principle viewpoint, it is impossible for the principle or the agent at zero cost to ensure that the agent will make optimal decisions. The agency cost is defined as the sum of: 1.The monitoring expenditures by the principal;

2. The bonding expenditures by the agent;
3. The residual loss;
Frank H. Easterbrook published the "Two Agency-Cost Explanations of Dividends" in 1984, expressed his basic view about the cash dividend. Easterbrook established the basic idea of the cash dividend agency cost theory in this literature. Easterbrook points out that in modern business, many shareholders are the principals and the manager is an agent. The shareholder is the owner of all the property of the company; the managers’...
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