AGENCY COST OF FREE CASH FLOW, FIRM PERFORMANCE AND MODERATING ROLE OF FINANCIAL LEVERAGE AND DIVIDEND POLICY: THE CASE OF PALESTINE CORPORATIONS
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Date
2022-09-22
Authors
Mahmoud Yousef Mahmoud
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Abstract
Background: Free Cash Flow (FCF) is considered one of the main sources of agency problems between management and shareholders. These problems result from separating management from owners and using this money in a way that does not serve the shareholders’ interests. This leads to harming the performance of the company. Therefore, the owners strive to control these behaviors by controlling the financial policies, thus reducing FCF in the hands of the managers.
Objectives: This study sought to find out the effect of overinvestment, as a proxy for the agency problem of FCF, on the company’s performance and the moderating role that both debt and dividend policies play in reducing the negative impact of overinvestment on the financial performance of companies in Occupied Palestine.
Methodology: The study participants were 31 non-financial companies listed on the Palestine Stock Exchange (PSE) from 2010 to 2019.The accounting data was collected manually from the financial reports (balance sheets and income statements) of the companies while the market data was collected from the PSE website. This study adopted overinvestment as a proxy for the agency cost of FCF; it was measured through the investment demand function. This study also used the Ordinary Least Squares (OLS) method to test these relationships.
Results: This study has found that overinvestment negatively affected the performance of companies in Occupied Palestine. It was measured by five accounting metrics: EBIT, EBT, ROA, ROE, and EPS. It has also found that debt could mitigate the negative impact of overinvestment on financial performance, which is consistent with Jensen's 1986 FCF theory. However, the study has not found evidence about the role of dividend policy in reducing the negative impact of overinvestment on the performance of companies in in the country. The combination of debt and dividend policies has not proven/yielded any significant effect.
Recommendations: Based on the study findings, the researcher recommends using debt as an effective tool to reduce agency problems for FCF in Occupied Palestine companies. He also suggests administering the study to the financial sectors and companies in neighboring countries to generalize the findings more reliably.
Keywords: Free cash flow; agency problem of FCF; dividend policy; debt policy; firm performance; Occupied Palestine.