Research On Inspection And Control Of Agency Cost Of Free Cash Flow

Free cash flow is generated by the production and operation of enterprises, and is the cash flow after meeting the funds required for the project of net present value greater than zero(Jensen,1986). The biggest characteristic of free cash flow is meeting the enterprises’ production and operation already, and the managers can use it at random. From the principal-agent theory, Jensen discussed agency cost caused by improper using of free cash flow under the premise that the agency conflicts between the shareholders and managers. Jensen pointed out that agency problem will generate when enterprise’s free cash flow is abundant. Shareholders want to distribute these free cash flow to Shareholders in the form of dividends, while managers want to possess these free cash flow in a variety of way, in order to improve their position in the market and vested interests. So a series of behavior of enterprise value damaging is caused, such as overinvestment and position-related consumption. Therefore, controlling free cash flow at a reasonable level and improving the efficiency of using free cash flow are effective ways to relief the agency conflict, improve the corporate governance structure, and increase the value of enterprise. Therefore, whether the agency cost of free cash flow is exist in China capital market? How about the extent? What influence it produced to the enterprise? All of these are important issues in this paper. On the other hand, when the enterprise’s free cash flow is insufficient, financing constraint of capital market caused by information asymmetry will cause the enterprise insufficient investment. The insufficient investment will bring the loss, including loss of investment opportunity, competition reducing and high financing cost. All of these produce the transaction cost of free cash flow. So enterprise should determine a reasonable level of free cash flow, in order to avoid high agency cost, maintain financial flexibility and grasp market opportunity timely. Further free cash flow is not only an important indicator to judge the quality of financial management, but also closely related to corporate governance structure and macroeconomic environment. Through the perfect and rational utilization of enterprise factors, related costs of free cash flow should be controlled, the efficiency should be improved, and enterprise value should increase ultimately. Therefore, testing the agency costs of free cash flow, studying the role of free cash flow to ease financing constraint, researching the control for agency costs of free cash flow, discussing the dynamic adjustment and optimization of free cash flow, and such similar studies have important theoretical and practical significance to improve capital efficiency, optimize resource allocation, and increase enterprise value.Based on combing the free cash flow theory and literature, this paper studied the test and control of agency cost of free cash flow along the main line of "agency cost of free cash flow test——financing constraint and free cash flow——agency cost control mechanism of free cash flow——research on the dynamic adjustment of free cash flow——recommendation on agency cost control of free cash flow". Firstly, this paper discussed the related theory and literature, analyzed the current situation of free cash flow in China listed company, and gave the calculation formula about free cash flow in this paper. Secondly, selecting overinvestment and position-related consumption as measure of agency cost, this paper studied the agency cost of free cash flow. This paper also studied whether the insufficient investment is existed and how about the extent under the financing constraint, and the role of free cash flow to ease financing constraint. Third, this paper selected four indicators:the level of debt, cash dividend, corporate governance, and accounting conservatism, and inspected the control of agency cost of free cash flow respectively. Fourth, this paper studied the dynamic adjustment of free cash flow and its relationship with the enterprise value, and studied the change of dynamic adjustment of free cash flow under the influence of the level of investment, financing constraint, and enterprise growth. Fifth, this paper made recommendations to control agency cost of free cash flow according to the result of free cash flow related problem analysis. Finally, the paper is summarized and prospected. The main conclusions of this study are as follows:First, this paper tested the agency cost of free cash flow using the capital market data of China. This paper selected overinvestment and position-related consumption as measure of agency cost variables, we found that the level of free cash flow has a significant positive correlation with overinvestment and position-related consumption, and the abundant free cash flow prone to produce agency cost. In terms of likelihood of occurrence of agency behavior, free cash flow holding will increase the possibility of overinvestment, but is not relevant to the possibility of position-related consumption. For state-owned enterprise, the degree of overinvestment and position-related consumption of free cash flow is more serious, and the agency cost is higher. In the study of the relationship between financing constraint and free cash flow, we found that insufficient investment of enterprise with financing constraint in China capital market is serious, and the degree is higher in non-state-owned and Midwest enterprise. But we also found that plenty of free cash flow can significantly reduce the insufficient investment, and ease the financing constraint. The enterprise facing financing constraint generally also reserve more free cash flow for a rainy day, and this relationship in state-owned and Midwest enterprise is more obvious. This paper also found that enterprise facing financing constraint has a positive free cash flow sensitivity of cash.Second, this paper studied related enterprise factors’controlling on agency cost of free cash flow. This paper selected the level of debt, cash dividend, corporate governance, and accounting conservatism, studied their influence to the overinvestment of free cash flow, and further studied their influence to insufficient investment.In order to examine their role in control agency cost and ease the insufficient investment. We found that the relationship between the level of debt and free cash flow is U-shaped curvilinear. When the level of debt is at25%quantile in the overall sample, the effect to curb overinvestment is greatest, and low or high levels of debt are not conducive to control the agency cost. For the different types of debt sources, the effect of short-term borrowing is biggest, and the long-term loans have contributed to overinvestment. Commercial credit has more significant effect than bank borrowing. Cash dividend did not play a significant role in curb overinvestment. A higher level of corporate governance and accounting conservatism is conducive to curb overinvestment, and the effect is more significant in enterprise of abundant free cash flow. For ease the insufficient investment, enterprise with high corporate governance level has a low degree of insufficient investment. But only this factor played a role, the other three factors did not play a role.Third, this paper studied the dynamic adjustment of free cash flow. Returning to Jensen’s definition of free cash flow, this paper selected the level of investment, financing constraint, and enterprise growth, and studied the adjustment direction and speed of free cash flow and the relationship between free cash flow and enterprise value under the influence of the three indicators. We firstly found that there is a gap between the free cash flow in China listed company and the target level, and adjusting to the target level will take some time and cost. We also found that enterprise with high level of investment has a faster free cash flow adjustment, enterprise with high level of financing constraint has a slower free cash flow adjustment, and enterprise growth is not relevant to free cash flow adjustment. Free cash flow adjustment in non-state-owned enterprise is faster than the state-owned enterprise and investment level and financing constraint’s influence in non-state-owned enterprise is more significant than the state-owned enterprise. Further, this paper used the threshold regression model study the relationship between free cash flow and enterprise value. We found that there is a single threshold effect between free cash flow and excess return, and the relationship between free cash flow and enterprise value is not a simple linear relationship. When free cash flow is in the low range, enterprise value will raise with free cash flow increased; and when it is in the higher range, enterprise value will reduce with free cash flow increased. After adding the level of investment, financing constraint and enterprise growth as threshold variables, the impact of free cash flow to excess return was show single threshold, double threshold and triple threshold respectively. And in the range of low level of investment, middle level of financing constraint, and middle level of enterprise growth, the promotion effect of free cash flow to excess return was is obvious.Fourth, this paper studied control of agency cost of free cash flow from the behavior of listed company standardize and improving external market discipline. The purpose of control mechanism studying is to control the free cash flow at a reasonable level, to minimize agency cost under the circumstance that company has sufficient free cash flow. This paper did this analysis mainly from the perfection of corporate governance structure, practice of capital budgeting and corporate dividends, and establishment of external constraint mechanism. In the aspect of corporate governance structure, this paper mainly considered the improvement of board of directors system and supervision and incentive of managers. State-owned enterprise should strictly implement the capital budgeting system, and Non-state-owned enterprise should try to regulate the behavior of dividend distribution. Establishment of external constraint mechanism includes perfecting the market restraint mechanism, strengthen the debt constraints, and attaching great importance to the media supervision. The purpose of management method studying is to regulate the daily use and management of free cash flow, and this paper mainly did this analysis from establishment and improving the information disclosure mechanism of free cash flow, implementation the budget management of free cash flow, and promoting the dynamic management of free cash flow.