JSSM  Vol.4 No.1 , March 2011
Agency Cost under the Restriction of Free Cash Flow
Abstract: Agency cost theory is an important branch of capital structural theory. Free cash flow has significant impact on agency cost. The combination of research on these two fields would help to build and extend the theoretical system. Based on agency cost theory, the present study firstly categorized the characteristics of free cash flow as well as the statistical methodologies. Furthermore, the existence of investing free cash flow in agency cost was proved by a model. Then free cash flow was introduced into agency cost theory as restriction, the analysis shows that it will change agency cost, in turn, will have an impact on the relationship between agency cost and capital structure, finally, will influence the optimal capital structure point to maintain the equilibrium. Concretely, with the increasing free cash flow, correspondingly, debt proportion will decrease.
Cite this paper: nullJ. Chu, "Agency Cost under the Restriction of Free Cash Flow," Journal of Service Science and Management, Vol. 4 No. 1, 2011, pp. 79-85. doi: 10.4236/jssm.2011.41011.

[1]   S. C. Myers, “The Capital Structure Puzzle,” Journal of Finance, Vol. 39, No. 1, 1984, pp. 575-592. doi:10.2307/2327916

[2]   S. C. Myers and N. S. Majluf, “Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have,” Journal of Financial Economics, Vol. 13, No. 2, 1984, pp. 187-221. doi:10.1016/0304-405X(84)90023-0

[3]   M. P. Narayanan, “Debt Versus Equity under Aysmmetric Information,” Journal of Financial and Quantitative Analysis, Vol. 23, 1988, pp. 39-52. doi:10.2307/2331023

[4]   P. H. Rubin, “Managing Business Transactions,” The Free Press, New York, 1990.

[5]   K. Lehn and A. Poulsen, “Free Cash Flow and Stockholder Gains in Going Private Transactions,” Journal of Finance, Vol. 44, No. 3, 1989, pp. 771-787. doi:10.2307/2328782

[6]   L. H. P. Lang, R. M. Stulz and R. A. Walkling, “A Test of the Free Cash Flow Hypothesis, the Case of Bidder Returns,” Journal of Financial Economics, Vol. 29, No. 2, 1991, pp. 315-335. doi:10.1016/0304-405X(91)90005-5

[7]   K. M. Howe, J. He and G. W. Kao, “One-Time Cash Flow Announcements and Free Cash Flow Theory: Share Repurchases and Special Dividends,” Journal of Finance, Vol. 47, No. 5, 1992, pp. 1963-1975. doi:10.2307/2329004

[8]   J. Doukas, “Overinvestment, Tobin’s Q and Gains from Foreign Acquisitions,” Journal of Banking and Finance, Vol. 19, No. 7, 1995, pp. 1285-1303. doi:10.1016/0378-4266(94)00117-L

[9]   A. G. Ferdinand, “Free Cash Flow, Debt-Monitoring and Managers’ LIFO/FIFO Policy Choice,” Journal of Corporate Finance, Vol. 7, 2001, pp. 475-492. doi:10.1016/S0929-1199(01)00037-2

[10]   J. Chu, “The Empirically Study on the Relationship between Free Cash Flow and Agency Cost,” The Sociologist, No. 5. 2007, pp. 159-161.