The Effects Of Free Cash Flow On The Returns Of Bidders

With the maximization of shareholders'wealth, free cash flow, which is up to the point where all positive net present value projects are founded, should be paid out. However, managers are the agents of shareholders. Their relationship is fraught with conflicting interests. In case, managers may pursue their own objectives and waste the free cash flow. This study will examine the effects of free cash flow on the returns of bidders.This paper is made up of five parts as following:The Introduction part, the first chapter, gives a brief description of the necessity of this study. For less effective monitoring, agency problems become very severe, and managers may pursue their own objectives through acquisition.The second chapter reviews studies about the theory of free cash flow. These researchers concentrate on subjects about capital structure and takeovers respectively.The third chapter describes the research methodology. This study examines a sample of 355 firms that announce asset or stock purchases from 1999 to 2002, and groups firms in the high G/high FCF*, high G/low FCF*, low G/high FCF*, and low G/low FCF*(FCF* is free cash flow scaled by the book value of its assets).The fourth chapter presents the process of empirical analysis. At first, this study compares returns of the four groups, and finds that the return of the low G/high FCF* is the worst, in the view of declining rate. And then, it regresses the returns against FCF*. The coefficient of the FCF* is negative and significantly different from zero at the 1% and 5% level respectively at the first and second year after acquisition. This implies that managers of firms with fewer growth opportunities may potentially be wasting cash by purchasing assets that have little or no value to shareholders.The last chapter summarizes the empirical study.