Agency Costs of Free Cash Flow

49 Pages Posted: 1 Oct 2015 Last revised: 7 Jul 2016

See all articles by Indraneel Chakraborty

Indraneel Chakraborty

University of Miami

Vidhi Chhaochharia

University of Miami - Department of Finance

Gerardo Perez Cavazos

Harvard Business School

Andreya Silva

Independent

Date Written: July 1, 2016

Abstract

Free Cash Flow (FCF) agency conflicts exist when managers divert cash flow for private benefits. We identify the impact of unobservable FCF conflicts on firm policy using a structural approach. Measurement equations are constructed based on observable managerial choices: payout policy changes and personal portfolio decisions around exogenous tax rate changes. We find that FCF agency conflicts cause (i) under-leverage, leading to higher corporate taxes and (ii) under-investment in PP&E, leading to slower firm growth. Capital markets recognize FCF conflicts and discount such firms. Finally, firms with (i) large institutional holdings or (ii) better-aligned executive compensation, suffer less from FCF agency conflicts.

Keywords: Free Cash Flow, Agency Costs, Dividend, Debt, Executive Compensation

JEL Classification: G24, G32, G14

Suggested Citation

Chakraborty, Indraneel and Chhaochharia, Vidhi and Perez Cavazos, Gerardo and Silva, Andreya, Agency Costs of Free Cash Flow (July 1, 2016). Available at SSRN: https://ssrn.com/abstract=2667761 or http://dx.doi.org/10.2139/ssrn.2667761

Indraneel Chakraborty

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
312-208-1283 (Phone)

HOME PAGE: http://sites.google.com/site/chakraborty/

Vidhi Chhaochharia

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

Gerardo Perez Cavazos (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Andreya Silva

Independent ( email )

No Address Available

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