Financial Theories Overview

5 May 2017

costs of capital to a firm would remain the same no matter what combination of financing sources the firm actually chose” (Miller, 2001, p. 185). The dividend proposition overcomes objection to leverage proof. | 3. Agency Cost Theory I Michael Jensen and William Meckling define agency costs as the costs associated with cooperative effort by human beings, which arises when the principal hires an agent to carry out duties Oensen, 2005).

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Conflicts of interest between management and shareholders are inevitable and can cause a potential loss in value of public corporations (Chew, 2001). For example, shareholders may want management to increase shareholder value, but management may grow the business to increase personal power and wealth (Chew, 2001). | Enron’s company was worth $30 billion and senior managers’ tried to defend a $40 billion of excess valuation.

Ultimately Enron executives destroyed the company “by trying to fool the markets through accounting manipulations, hiding debt through off-balance sheet partnerships, and over hyped new ventures such as their broadband futures effort” Oensen, 2005, pp. 10-11). John Roth, former chief executive officer (CEO) of Nortel, wrote off most cquisitions, when stock price crashed and closed down activities, which resulted in the destruction of not only the corporate value but also the social value of the company Oensen, 2005). Finance scholars found a reduction in conflict of interest between management and shareholders because of: (1) product market competition and a market for executive labor

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