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The Agency Costs of Free Cash Flow: Acquisition Activity and Equity Issues

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  • Mann, Steven V
  • Sicherman, Neil W

Abstract

Michael C. Jensen argues that there are agency costs associated with free cash flow. This study extends that argument and posits that shareholders condition their valuation decisions on firms' reputations regarding free cash flow abuse. The authors test this notion by examining share price responses to equity offers, which generally exacerbate the cash flow problem, for firms differentiated by their recent acquisitive behavior. The results suggest that shareholders react more favorably to equity issue announcements if firms have acquired only assets related to their core business than to other equity issue announcements. Copyright 1991 by University of Chicago Press.

Suggested Citation

  • Mann, Steven V & Sicherman, Neil W, 1991. "The Agency Costs of Free Cash Flow: Acquisition Activity and Equity Issues," The Journal of Business, University of Chicago Press, vol. 64(2), pages 213-227, April.
  • Handle: RePEc:ucp:jnlbus:v:64:y:1991:i:2:p:213-27
    DOI: 10.1086/296534
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    Citations

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    Cited by:

    1. Michael C. Jensen, 2010. "The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(1), pages 43-58, January.
    2. Yu, Chih-Ping, 2015. "Financial policies on firm performance: The U.S. insurance industry before and after the global financial crisis," Economic Modelling, Elsevier, vol. 51(C), pages 391-402.
    3. Tom D. Holden & Paul Levine & Jonathan Swarbrick, 2017. "Credit Crunches from Occasionally Binding Bank Borrowing Constraints," Staff Working Papers 17-57, Bank of Canada.
    4. Hyun Mo Sung, 1993. "The Effects Of Overpayment And Form Of Financing On Bidder Returns In Mergers And Tender Offers," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 16(4), pages 351-365, December.
    5. Viral V. Acharya & Alberto Bisin, 2009. "Managerial hedging, equity ownership, and firm value," RAND Journal of Economics, RAND Corporation, vol. 40(1), pages 47-77, March.
    6. Pascal Louvet & Ollivier Taramasco, 2004. "Gouvernement d’entreprise:un modèle de répartition de la valeur créée entre dirigeant et actionnaire," Revue Finance Contrôle Stratégie, revues.org, vol. 7(1), pages 81-116, March.
    7. Fayez A. Elayan & Thomas O. Meyer & Jingyu Li, 2006. "Evidence from Tax-Exempt Firms on Motives for Participating in Sale-Leaseback Agreements," Journal of Real Estate Research, American Real Estate Society, vol. 28(4), pages 381-410.
    8. Trien Le & Trevor Buck, 2011. "State ownership and listed firm performance: a universally negative governance relationship?," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 15(2), pages 227-248, May.
    9. Hsuan-Chu Lin & She-Chih Chiu, 2017. "Tradeoff on corporate cash holdings: a theoretical and empirical analysis," Review of Quantitative Finance and Accounting, Springer, vol. 49(3), pages 727-763, October.
    10. Yongqiang Chu & Peng Liu, 2016. "A Direct Test of the Free Cash Flow Hypothesis: Evidence from Real Estate Transactions," The Journal of Real Estate Finance and Economics, Springer, vol. 52(4), pages 543-558, May.
    11. Maquieira, Carlos P. & Megginson, William L. & Nail, Lance, 1998. "Wealth creation versus wealth redistributions in pure stock-for-stock mergers," Journal of Financial Economics, Elsevier, vol. 48(1), pages 3-33, April.
    12. Rodolfo Apreda, 1999. "The Cash Flow Model with Float: A New Approach to Deal with Valuation and Agency Problems," Journal of Applied Economics, Universidad del CEMA, vol. 2, pages 247-279, November.
    13. Chang, Che-Chia & Kao, Li-Han & Chen, Hsin-Yu, 2018. "How does real earnings management affect the value of cash holdings? Comparisons between information and agency perspectives," Pacific-Basin Finance Journal, Elsevier, vol. 51(C), pages 47-64.

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