Dividend, Free Cash Flow Hypothesis And Abnormal Returns

Free cash flow hypothesis thinks that the payout to shareholders helps to reduce the resources under managers’control after their formal investment, thus avoiding over-investment and alleviating conflicts of interest between the shareholders and managers so as to maximize the corporate value. Our country has a lower proportion of cash dividend distribution among the listed companies because of our incomplete securities industry system, and firms began to distribute cash dividends when the China Securities Regulatory Commission announced the rules in2000that listed company could attain the refinance qualification only when it meets the requirements on the cash dividends in the recent three years. However, the level of the cash dividends of our listed companies is lower compared to the west, in addition, the dividends distribution is not he earning distribution but for the refinancing so that the interest of our minor shareholders can’t be protected effectively. With the hard rules about the associations between refinancing and cash dividends in recent years indicate that regulatory authorities are paying more and more attention to the dividend policy which is one of the core content of Corporate Finance. Most research papers in our country focus on the point of view of agency costs to examine the dividend policy and seldom use the event-study method to examine the market react to the dividend initiation announcement. With the continued improvements of information disclosure systems and the great attention which the investors pay to the all sorts of information when they make investment decisions, the research on the various announcements has significant academic value. Besides that, the managers in the companies which have ample free cash flow and few investment opportunities are inclined to engage in the activities about on-the-job consumption and diversify investments without profitability prospect so as to achieve their personal compensation. Hence, research on the classification of investment opportunities and free cash flow has important practical value.This article takes the all the listed companies except the utilities and financial services industries in the main board of the A-share market as sample, and adopts the event-study method to examine the impact of the dividend initiation announcement on the share prices. The study result indicates that the dividend initiation announcement can bring about the significantly positive cumulative abnormal returns. And the value-weighted cumulative abnormal returns are lower than the equal-weighted cumulative abnormal returns on the whole, we can arrive at the conclusion that the firm size has impact on the market react to the dividend announcement. Then we regard the Tobin Q as the proxy variable of the investment opportunities, and sort the sample by the Tobin Q and free cash flow to investigate the difference in the cumulative abnormal returns of sub-samples. As a result, the low Tobin Q/high free cash flow companies have higher cumulative abnormal returns than other companies. The managers in this type of companies which has few investment opportunities and ample free cash flow are inclined to waste the cash resources, which will result in higher agent costs. It supports the free cash flow hypothesis effectively. We introduce other control variables and adopt OLS regression examine the factors that influence the market react to the dividend initiation announcement, and the results suggest that the marginal impact of free cash flow on the initiating firms with low Tobin Q is significantly positive, which demonstrate the result of the comparative study. Lastly, the study provides some constructive suggestions according the results of the investigation. We hold that the securities regulatory commission should strengthen the regulation of the listed companies, make some hard rules on the standard of the cash dividend and punitive measures. In addition, we should improve the information disclosure system in our country, thus enhancing the corporate transparency and make effective protection of the interests of investors. At the same time, increasing the proportion of institutional investors and making the ownership structure reasonable should not be neglected. We also need to help the outside director to strengthen the supervision in the operations of the companies and provide effective incentives for the managers, which would boost the raise our level of corporate governance.