In his original model, Marris advocated that corporate growth, g, could be manipulated to maintain an optimum dividend-to-profit retention ratio that keeps the shareholders satisfied but does not retain too high a level of profit, creating a cash-rich business ripe for a take-over. This implies a degree of control on share value that would seem difficult to sustain for even the most effective management team. There are simply too many other factors that could affect the valuation ratio of the business beyond corporate growth. Deciding on how best to achieve growth becomes a crucial issue for management during the life cycle of a firm.
For example, if management wish to grow by product diversification there is a constraint inherent in the Marris model, the gd equation, that is fairly acute for firms that opt to grow through product diversification rather than by acquisition:
gd = f.(d, k)
Where d is the dividend rate and the parameter k represents the percentage of successful new products. The k parameter ultimately depends on R&D, advertising and promotion; and the $ spend on these variables depends on the profits that ultimately depend on the efficiency of the firm.
There is a benchmark rule: the higher the valuation of a company the less likely is the threat of takeover. This rule, however, intimates that dividends should stay high to maintain the share price. Alternatively management may wish to invest more profits to secure more growth with a risk that the value of the company falls. If the higher valuation were perceived by shareholders to be at a maximum then shareholders would prefer that higher valuation, so it behoves management to persuade shareholders that the risk of a fall in value can be captured by a higher growth rate. Management inability to persuade shareholders gives rise to agency costs.
One way to tackle the agency costs is for management to design a trust mechanism between shareholder...