Free Cash Flow Hypothesis Research Articles

Open Market Repurchases and Signaling Hypothesis

This paper analyzes the impact of open market repurchase (OMR) route of buyback on the stock prices of a data set of 30 Indian listed firms which had gone for buyback in the FY16. The author has applied event study methodology to calculate abnormal returns and cumulative abnormal returns on stocks using BSE 500 as market index. The returns are calculated for 20 days prior and post buyback announcement to test for information signaling hypothesis. The analysis shows that average abnormal return (AAR) on the date of announcement is -0.23 percent while cumulative abnormal return (CAR) is about 5.72 percent on the announcement date with an overall CAR 3.44 percent for 40-day event window. The research findings reveal that unlike tender offers, OMR does not lead to a signaling effect as there is the insignificant impact on stock prices. Market reaction to buyback offer is in contradiction to signaling hypothesis predictions. The results of the study imply that the information related to the announcement of the buyback is already reflected in the share price. This also throws light on the growing maturity and efficiency of the stock market of India. Analyzing the signaling effect through OMR reveals that rather than signaling hypothesis, market reaction to buybacks is better explained by free cash flow hypothesis.

IPO valuation and offering size

Using a sample of 4441 IPOs from the US, we find that IPO firms with larger proportional offering size have lower valuation. The sizes of both primary share offering and secondary share offering are negatively related to IPO firm valuation. The valuation measures are positively related to the levels of capital expenditure and R&D before IPO, lending support to explanations based on Jensen (JAMA 76:323–329, 1986)’s free cash flow hypothesis. We also find evidence consistent with negative signals from larger secondary share offering size. Results of tests about long-run IPO stock performance do not support the hypothesis that IPO stock demand curve is downward sloping.

How institutional monitoring creates value: Evidence for the free cash flow hypothesis

Institutional ownership of U.S. equities increased from 9.4% in 1980 to 42.9% in 2009. This paper analyzes the indirect role of institutional investors in monitoring firm managers and in the process of shareholder wealth maximization. Institutional monitoring reduces the agency problem of free cash flow. Controlling for reverse causality, we find that increased institutional ownership results in lower leverage and dividend payout that consequently lead to greater cash holdings and firm value. The results are consistent with the free cash flow hypothesis and provide an alternative explanation for why firms hold so much cash and why debt and dividends have decreased during the last thirty years.

The wealth effects of public-to-private LBOs: Evidence from Europe

This study examines various features of leveraged public-to-private institutional buyouts in Europe that occurred between 1998 and 2016. We find significant excess returns of about 7.7% on the LBO announcement date. We also find evidence that LBOs harbored in countries with strong corporate governance mechanisms elicit greater wealth effects for shareholders of targets. Consistent with the free cash flow hypothesis, abundance of cash appears to be one of the driving forces of excess short-term returns. Looking at the characteristics of LBO targets, we show that mature companies with excess cash flows and less volatility seem to be candidates for LBO deals.

Is Excess Free Cash Flow Over-Invested? Evidence from Borsa İstanbul

In a perfect capital market, investments should not be related to cash flows of the firm. Investments should only be determined by the amount of renewal investments required and growth opportunities available to the firm. Contrarily, due to the conflicts of interest between the managers and the shareholders, the theory on agency costs and free cash flow hypothesis propose that managers are inclined to over-use free cash flow, which is in excess of value-adding investments. It is claimed that firms invest their extra free cash flow on projects with returns below cost of capital of the firm. Some prior studies made on the topic implied the validity of this hypothesis. In other words, firm’s resources might be wasted by means of over-investing. This study, based on a panel data of 154 Borsa Istanbul firms observed between 2005-2015, confirmed that firms over-invest when there is free cash flow available in excess of growth opportunities and dividends. Prior studies have used mostly regression models or Tobin’s q to estimate investment prospects of the firm. However, this study adopted a direct method to estimate investment opportunities available to the firm.

Why Do Firms Repurchase Their Stocks? Evidence from an Emerging Market

Though it has recently become a contemporary financial management tool, stock repurchase can be so dangerous that it may raise concerns about insider trading and manipulative transactions. In fact, such concerns underlie the most important critique of stock repurchase and justify its prohibition, at least its restriction, in several jurisdictions to date. Turkey, as one of these jurisdictions, has latterly been updated in order to allow open market stock repurchases with certain restrictive provisions. We intend to explore why Turkish firms decide to repurchase their stocks. Having employed a conditional logistic regression model, the results reveal that signaling hypothesis, i.e. undervaluation and positive information dissemination, and excess capital and free cash flow hypothesis, i.e. excess cash distribution, hold for Turkish companies.

The Role of Cash Holdings in Corporate Misconduct

We test the role of cash holdings in corporate misconduct. Consistent with the agency costs of equity overvaluation, before misconduct, investors overvalue firms’ cash holdings, and firms that commit misconduct accumulate excess cash holdings. Furthermore, consistent with the free cash flow hypothesis, the accumulated excess cash holdings at the beginning of misconduct positively predict firms’ simultaneous misconduct actions, including overinvestment decisions, the delay of bad news disclosures, and insider selling. The association of excess cash holdings with the degree of withholding bad news and insider trading occurs mainly in firms with higher managerial equity-based incentives or firms with internal control weakness. The results suggest that cash holdings are one important mechanism by which equity overvaluation leads to corporate misconduct and emphasize the importance of internal control over financial reporting in safeguarding corporate resources.

Testing the Relationship between Free Cash Flow and Company Performance in Borsa Istanbul

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.

The impact of equity ownership groups on investment: Evidence from Ukraine

We empirically investigate the impact of different ownership groups on companies’ investment in Ukraine with a novel dynamic investment model where investment is based on present and historical levels of profitability (market-to-book value of equity) and lagged investment. Groups include state, insider, non-domestic, financial and financial and industrial group (FIG) ownership. Contrary to the literature, we find that the past level of profitability significantly affects investment; the majority presence of and increases in state ownership have a negative impact on firms’ investment, as is the case for non-domestic and financial companies’ ownership. Insider and FIG ownership have no impact on investment. We explain the results by the extent of liquidity concerns (hard and soft budget constraints), measured by cash flow interacted with a dummy variable of majority ownership of the respective group, and the extent of asset stripping for the corresponding ownership group and relate them to over- and under-investment, and to the free cash flow or cash constraint hypothesis.

Is the free cash flow hypothesis valid in Turkey?

This study tests the validity of the free cash flow hypothesis in the context of firms traded on Borsa Istanbul. The study applies a panel regression to a data set composed of 1267 observations from 227 companies during the period 2008–2014. The results reveal a significant, negative correlation between dividends per share and free cash flow. Likewise, a significant, inverse relationship is found between leverage and free cash flow. Thus, the results support the free cash flow hypothesis.

WHY DO FIRMS REPURCHASE THEIR STOCKS? EVIDENCE FROM AN EMERGING MARKET

Though it has recently become a contemporary financial management tool, stock repurchase can be so dangerous that it may raise concerns about insider trading and manipulative transactions. In fact, such concerns underlie the most important critique of stock repurchase and justify its prohibition, at least its restriction, in several jurisdictions to date. Turkey, as one of these jurisdictions, has latterly been updated in order to allow open market stock repurchases with certain restrictive provisions. We intend to explore why Turkish firms decide to repurchase their stocks. Having employed a conditional logistic regression model, the results reveal that signaling hypothesis, i.e. undervaluation and positive information dissemination, and excess capital and free cash flow hypothesis, i.e. excess cash distribution, hold for Turkish companies.

Open Market Share Repurchases in Germany: A Conditional Event Study Approach

We analyze the decision to announce an open market share repurchase and the share price reaction to the announcement. We use a conditional estimation approach, which takes into account that the repurchase decision is made rationally and that, consequently, there is a potential selection bias. This approach requires a ‘non‐event sample’ of firms that could reasonably be expected to announce a repurchase but did not. The specific institutional rules for share repurchases in Germany allow us to construct such a sample. We find that a conditional approach yields results that are qualitatively comparable but differ in detail from those obtained using a non‐conditional approach. We confirm earlier findings of negative share price performance prior to the repurchase announcement and positive and significant announcement day abnormal returns. The results of our probit models are consistent with the free cash flow hypothesis and provide at least partial support for the rent extraction, signalling, and capital structure hypothesis. The results of the cross‐sectional regressions provide support for the signalling hypothesis once we control for selection bias.

The Research on the Measurement of Inefficiency Investment Degree of China's GEM Listed Companies

October 30, 2009, the GEM officially launched, which was an important step to improve China's capital market system. For the listed companies, investment efficiency is one of the three major investment decisions. Due to the short period of study, the research area is less related to the GEM listed companies.Theoretically, in the perfect market described by Modigliani and Miller, investment decisions are totally determined by investment opportunities, regardless of the impact of other factors. But in the real world of imperfections, agent problems and information asymmetry can lead to inefficient investment. From the point of view of the Principal-agent Theory and the Free Cash Flow hypothesis, the principal-agent conflict between the shareholders and the senior managers leads to the fact that the senior managers maximize their own utility and put the free cash flow into the project whose net present value is not greater than zero. In the information asymmetry theory and financing constraints hypothesis, the information asymmetry between the company and the external investors will make it difficult for external investors to make an accurate valuation of the company. To reduce the loss of the risk, they tend to underestimate the value of the company, so the financing cost of company in the capital market have been raised, and when the internal cash is in the shortage, the senior managers do not want to choose external financing with high cost to meet the investment need, to give up investment in project whose the net present value is larger than zero, resulting in underinvestment.At the level of empirical analysis, this paper chose the financial data and market transaction data of the GEM listed companies from 2010 to 2015 to study. Based on the Expected Investment Model of Richardson (2006), this paper used the generalized difference moment method (GMM) to estimate the expected additional investment, with the amount of investment, resulting in overinvestment and underinvestment. The conclusion is that there are overinvestment behavior and underinvestment behavior of the GEM listed companies in the research period.This paper measured the level of inefficient investment of listed companies on the GEM, so that the micro-subject in the multi-level capital market can clearly define the direction of its own need. In addition, we also hope to provide empirical reference for the policy makers in the formulation of relevant policies to create a good market environment for listed companies.

Does China overinvest? Evidence from a panel of Chinese firms

This paper uses a dataset of more than 100,000 firms over the period of 2000–2007 to assess whether and why Chinese firms overinvest. We find that corporate investment is more efficient in the non-state sector. Within all ownership categories, we uncover evidence indicating a degree of overinvestment among firms that invest more than their industry median or more than their predicted optimal investment. The free cash flow hypothesis provides a good explanation for China’s overinvestment in the non-state sectors, whereas in the state sector, overinvestment is attributable to the poor screening and monitoring of enterprises by banks.

Free cash flows and overinvestment: Further evidence from Chinese energy firms

In the recent years, Chinese energy firms have accumulated significant free cash flows due to higher energy prices and government subsidies and also have invested heavily. An important empirical question is whether the Chinese energy firms tend to misallocate resources due to growing free cash flows. In this paper, we test whether they make some sub-optimal investment decisions following the well-established free cash flow problem in the finance literature, originally identified by Jensen (1986) for the US oil sector. Using a dynamic panel model for the period 2001–2012 for the Chinese energy-related public listed firms, we find evidence supporting the free cash flow hypothesis, suggesting overinvestment problems in the Chinese energy sector. In addition, we observe that firm size and corporate governance structure are important determinants of the Chinese energy firms' investment decisions.

Information Content and Intra‐industry Effects of Cash Refund Capital Reduction Announcements in Taiwan

AbstractCapital reduction through returning cash to shareholders is one mechanism by which firms distribute their surpluses. While distribution of excess funds can lower agency costs, it may also signal a decline in the firm's future investment opportunities. In this paper, we examine the information content and information transfer effects of the announcement of capital reduction and cash distribution in Taiwan during the period 2002–2010. We find that there is a significantly positive market reaction when Taiwanese firms announce a reduction in their capital and return cash to shareowners. We also document contagion intra‐industry effects by showing that portfolios of rival firms in the same industry experience a significant and contemporaneous positive stock price performance. Consistently, our results support the free cash flow hypothesis of contagion intra‐industry effects in the long‐run stock return and operating performance of firms following cash refund capital reduction announcements. Moreover, multivariate analysis indicates that these contagion effects are influenced by competitors' features, which are negatively correlated with competitors' size and growth opportunity, and positively influenced by their dividend policy and ownership structure.

Ownership Structure and Dividend Policy of Listed Deposit Money Banks in Nigeria: A Tobit Regression Analysis

Free cash flow hypothesis posit that regular paying of dividend can reduce agency conflict and through this, the range of future probable misuse of resources by management reduces. Ownership structure has been identified to have relationship with dividend policy of a firm. Though the relationship is different for different class of owners and at different level; it does not influence dividend policy uniformly. Although, the linkage between the two has been monitored by many researchers, yet empirical researches do not provide consensus as to the direction of the relationships. Thus, the paper investigates the likelihood impact of ownership structure on dividend policy in the context of agency relation while using managerial ownership, institutional ownership, ownership concentration and foreign ownershipon dividend policy in the listed Deposit Money Banks (DMBs)in Nigeria. The research designs are Correlational and ex-post facto using secondary data extracted from the sampled companies’ annual financial reports for the period 2010-2014. Maximum likelihood (panel data tobit regression) is adopted as a technique of analysis for the study, using a sample of ten (10) out of seventeen (17) listed DMBs in Nigeria that served as population. The result shows that managerial ownership and ownership concentration are likely to have significant negative impact on dividend policy of listed DMBsin Nigeria, while institutional ownership is found to have likely significant positive impact on dividend policy of listed DMBs in Nigeria. But foreign ownership is found not to have likely significant impact on dividend policyof listed DMBsin Nigeria. Based on the findings, it is recommended among others that policy makers (Security and Exchange Commission and Corporate Affairs Commission) to design future policies where dividend payment could be facilitated and the diverse range of shareholders to be satisfied most especially minority shareholders. And that a limit should be set for managers on the proportion of shares to be held as this can facilitate dividend payment.

A Direct Test of the Free Cash Flow Hypothesis: Evidence from Real Estate Transactions

This paper tests (Jensen The American Economic Review, 76, 323–329 1986) free cash flow hypothesis using data on real estate transactions. We find that firms with either higher free cash flow or higher cash reserve pay more fore real estate, which is consistent with the free cash flow hypothesis. We also find that the agency costs of free cash flow associated with real estate transactions are more severe when firms have lower Tobin’s Q. Furthermore, we find that among the commonly used corporate governance measures, only equity compensation is effective in mitigating the agency problem of free cash flow.

EGYPTIAN MARKET REACTION TO OPEN MARKET SHARE REPURCHASE

ABSTRACT This paper examines the share price behavior surrounding share repurchase announcements made by Egyptian firms from 2006 to 2014. In the USA firms, repurchase announcements in Egypt are met with a positive and significant share price response. In addition, we investigate the motives of Egyptian firms for engaging in repurchase programs using Logit regression. Our results indicate that share price performance, size, and cash consistently have a significant impact on share repurchase announcements. On the other hand, leverage and payout ratios do not explain the decision of share repurchase announcement. The findings support the undervaluation hypothesis and the free cash flow hypothesis as motives for announcing share repurchase programs, while reject the leverage hypothesis and the dividend substitution hypothesis. Finally, using Tobit model we investigate the determinants of the repurchase program completion ratios. The findings indicate that announcement return, firm's size, and frequency have a significant influence on the firm's completion ratio. Keywords Share Repurchases, Egyptian Stock Market, Repurchase motives, Completion ratio.

The Capital Investment Increases and Stock Returns

This paper applies free cash flow and information asymmetry hypotheses to investigate whether managers pursuit their private benefits by using capital investment expenditure (hereafter CI) increases or not, and to explore whether managers decrease CI as more dividend payments under information asymmetry hypothesis. Consequently, the present study investigates the effect of CI increases on abnormal stock returns of Taiwanese listed firms. The empirical results show that during full period and the post financial tsunami period, the effects of an increase in CI on stocks returns are positive, and the CI-spread is negative. This supports the hypothesis of information asymmetry. However, in the electronics industry during the entire study period and the post financial tsunami period, the expenditure of low CI tends to support free cash flow hypothesis but that of high CI supports the hypothesis of information asymmetry.