Abstract
This study aims to investigate free cash flow hypothesis proposed by Jensen (1986). Data pertaining to 102non-financial firms listed on ASE during the period of 1998–2009 are analyzed using pooled and panel datamethods. Contrary to Jensen (1986) proposition, we found that debt and dividend are not substitute techniquesfor mitigating agency costs of free cash flow in the Jordanian capital market, rather, they are complementary toeach other. However, debt is used more than dividend for stability consideration of dividend policy where the useof debt and dividend is largely affected by dividend smoothing and leverage target adjustment considerations.Moreover, we found that low growth firms use debt more than dividends.
Highlights
The “classic” propositions made by Modigliani & Miller (1958, 1963) ignore the presence of information, agency and bankruptcy costs
The results of the Lagrange Multiplier (LM) and Hausman tests show that the random effects regressor is more effective than other regressor to generate efficient estimations
Lagrange multiplier (LM) found to be statistically significant at 1% level while Huasman test found to be statistically insignificant
Summary
The “classic” propositions made by Modigliani & Miller (1958, 1963) ignore the presence of information, agency and bankruptcy costs They assume that managers acts exclusively for shareholders benefits with no information asymmetry, so investors and management possess the same information about the firm’s future potential investments. Jensen and Meckling (1976) suggest that the separation of ownership and management encourages managers to give the priority for their own interests or benefits This situation creates agency costs incurred by the owners who should work effectively to reduce the effect of these costs on their wealth. Gillan and Starts (2003) pointed out that the agency problem may be magnified by the disperse nature of corporate ownership This is because small shareholders have no incentive for bearing the cost of controlling the management behavior
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