An Empirical Test On The Debt Monitoring Hypothesis

The frequency of the concept of Free Cash Flow that we can see in modern financial theory and practice is increasing, and it becomes to be a focus topic. The hypothesis of Free Cash Flow also attracts a great of attention from many academics since it was put forth. It not only occupies a very important position in financial theory, but also plays an important role in the practice. Debt Monitoring Hypothesis is one important assumption of two hypothesis of Free Cash Flow Theory. The theory said, to a company that not only indulged in low-growth but also had too much FCF it was much possible for the managers to use these cash in some suboptimal projects or private consumption, so the agency problem of FCF emerged. The hypothesis alsogave the solution------'debt monitoring', i.e. debt can monitor and reduce this kind ofagency costs, because the pressure of repay for the debt can restrain the managers' tendency to misuse the cash resource. Based on this point, the paper intend to testify if china's companies have made use of this solution to control agency costs, then prove the FCF theory.The framework of this paper was divided into three parts. Part 1 included Chapter 1, 2 and 3. Chapter 1 gave a simple introduction about this research. Chapter 2 was the theoretical background, emphasized on the introduction of hypothesis of FCF and the debt monitoring; Chapter 3 was the reality background in China. The second part, Chapter 4, was the nuclear of this paper, we proposed the "debt monitoring" and other three relevant hypotheses, then set three models as dependent variable and FCF as the most important independent variable, divided the sample into two panels according to the growth or the firm size, and tested the hypothesis via debt monitoring. The last part was Chapter 5 about the research conclusion , and the strategy and suggestion, and about the limitations and the future research ideas.The test results of this paper were:①the low-growth companies supported the debt monitoring hypothesis;②the high-growth companies show the evidence to support the hypothesis;③the paper didn't find the evidence that the debt monitoring was only used by big firms, but not by small firms;④the hypothesis about the substitution between debt and cash dividend wasn't be supported. Total in all, the first and the second results supported the hypothesis of FCF via 'debt monitoring'.