Abstract
This study tests whether free cash flow affects the performance of firms in the context of the free cash flow hypothesis. The study applies a panel regression method to a data set consisting of 2,175 observations belonging to 370 companies listed in Borsa Istanbul during the period 2009-2015. A significant, negative relationship is found between free cash flow and firm performance measured by Tobin’s Q ratio. Greater free cash flow in the hands of managers leads to the lower performance and, conversely, less free cash flow in the hands of managers leads to higher performance. The results also confirm that leverage and dividend payments have a positive effect on performance. Thus, the results support the free cash flow hypothesis for Turkey.
Highlights
As financial markets develop, the importance placed on corporate governance increases
When the interests of company managers and those of shareholders are in conflict, agency cost arises due to the agency problem
This can lead to the use of free cash flow for investments with a negative net present value or lavish expenditures not directly related to company operations, having a negative impact on company performance
Summary
The importance placed on corporate governance increases. Turkey included, are taking steps the field of corporate governance by advancing its principles and putting regulations in place. After calling attention to the agency problem, Jensen (1986, 1993, 1999) used agency theory as a launching point to propose the free cash flow hypothesis According to this hypothesis, company managers prefer possess free cash flow that they can manipulate. They tend to use free cash flow for their own interests rather than those of shareholders This leads, in particular, to investment in projects with negative net present value (Jensen, 1986; Jensen & Meckling, 1976). Managers prioritize their own interests, making expenditures or poor decisions that result in losses known as agency cost that have a negative impact on company performance
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