Abstract
Excessive free cash flows can lead to high agency problems as retaining free cash flow reduces the ability of capital market to monitor managers. Managers are also likely to waste the free cash flow on value-decreasing investments. Based on the free cash flow hypothesis, this study examines the relationship between corporate governance and firm performance of a sample of high agency costs of free cash flow firms, which is defined as firms that have high free cash flow and low investment opportunities. The sample firms are extracted from firms listed on the S&P/TSX composite index between 2009 and 2012. Using corporate governance scores provided by The Globe and Mail, this study finds that better corporate governance is associated with better firm performance, measured by return on equity. The results highlight the importance of corporate governance in protecting shareholders’ interests.
Highlights
The free cash flow (FCF) hypothesis (Jensen, 1986) suggests that managers are likely to invest in projects that are not in the best interests of the shareholders when they have more cash than is needed to fund all positive net present value (NPV) investments
This study contributes to the literature by providing more concrete evidence on the relationship between corporate governance and firm performance by focusing on a sample of firms that are considered to suffer from high agency problems
Since corporate governance can reduce the agency problems between managers and shareholders, the aim of this study is to examine the relationship between corporate governance and firm performance for high agency costs of FCF firms
Summary
The free cash flow (FCF) hypothesis (Jensen, 1986) suggests that managers are likely to invest in projects that are not in the best interests of the shareholders when they have more cash than is needed to fund all positive net present value (NPV) investments. This study contributes to the literature by providing more concrete evidence on the relationship between corporate governance and firm performance by focusing on a sample of firms that are considered to suffer from high agency problems. Since corporate governance can reduce the agency problems between managers and shareholders, the aim of this study is to examine the relationship between corporate governance and firm performance for high agency costs of FCF firms. We test if high agency costs of FCF firms with poorer corporate governance are associated with lower firm performance. Based on a sample of high agency costs of FCF firms listed on the S&P/TSX composite index between 2009 and 2012, this study finds that firms with better corporate governance (measured by corporate governance scores provided by The Globe and Mail ) have higher firm performance (measured by return on equity). Empirical results and conclusions are presented in the last section of the study
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