Investigating the Over- and Under-Sensitivity of Investment to Firms' Free Cash Flows (With Emphasis on Agency Costs and Financial Constraints)

Maryam  Farahani; Mohammad Hassani

doi:10.63053/ijmea.79

Authors

Maryam Farahani Master's Degree, Department of Accounting, Faculty of Management and Social Sciences, Islamic Azad University, North Tehran Branch, Iran
Mohammad Hassani Assistant Professor, Department of Accounting, Faculty of Management and Social Sciences, Islamic Azad University, North Tehran Branch, Iran

DOI:

https://doi.org/10.63053/ijmea.79

Keywords:

Free cash flow, agency costs, financial constraints, overinvestment, underinvestment, investment inefficiency.

Abstract

Free cash flow leads to investment inefficiency (over- or under-investment) which is rooted in information asymmetry between managers and shareholders, agency issues and financial constraints. This study examines the sensitivity of over- and under-investment to free cash flow. The dependent variable is investment inefficiency (over- or under-investment) and the independent variable is the firm's free cash flow. Control variables include growth, size, age, return on assets and financial leverage. Agency costs and financial constraints are also considered as moderator variables. The statistical sample included 260 companies listed on the Tehran Stock Exchange during the period 2006-2013. Using multivariate panel data regression models, the results showed that investment inefficiency has a significant and positive sensitivity to free cash flow. This sensitivity is significant and positive in observations that are associated with less investment and negative free cash flow due to financial constraints. Also, in observations that are associated with higher investment and positive free cash flow due to agency costs, this sensitivity is significant and positive.

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