Free Cash Flow, Managerial Ownership, and Agency Cost: A Nonlinear Evidence From Nigerian Quoted Consumer and Industrial Goods Firms

Abstract

This study focuses on a nonlinear approach in assessing the effect of free cash flow and managerial ownership on the agency cost of firms listed under the Consumer and Industrial Goods sector in the Nigerian Stock Exchange (NSE). Based on the extant theories, firms with high free cash flow are more exposed to agency costs. Existing literature however shows that managerial ownership could moderate this tendency. In this study, we argue that the extent to which managerial ownership moderates the effect of free cash flow on firms’ agency costs is dependent upon the level of the ownership, and thus, the moderation effect is not entirely linear. The study therefore empirically investigates whether free cash flow has a significant positive effect on agency costs; whether managerial ownership has a nonlinear effect on free cash flow; and whether the moderating effect of managerial ownership on the association of free cash flow and agency costs is nonlinear (not the same at different levels [Formula: see text]25% and above 25%). We estimate the panel regression using data from 2009 to 2015 to test three main hypotheses. We measured free cash flow using the cash flow approach and adopted the inverse of asset utilization to proxy for agency costs. The findings reveal that while free cash flow linearly and negatively affects agency costs, managerial ownership has a nonlinear effect on free cash flow and on the effect of free cash flow on agency costs. In line with the findings, this study concludes that managerial ownership is not a straight jacket remedy for tacking problems associated with agency costs that results from having excess free cash flow. Further studies should consider other proxies of agency costs.

Audit Quality, Ownership Structure, and Agency Cost in Nigerian Quoted Industrial Goods Firms

“…Thus, this shows that managerial ownership and agency cost have a positive relationship. When a manager possesses a substantial stake in the company, he or she assumes full responsibility for all decisions, including those regarding the use of payout policy (Yero, Abubakar, Hamman & Saidu, 2021). He pursues his own objectives without concern for retribution (Guizani, 2018).…”

Foreign Ownership, Free Cash Flow, and Assets Utilization of Manufacturing Industry

“…In addition, free cash flow increases agency costs (Ahmed AL-Dhamari & Nor Izah Ku Ismail, 2014;Barger et al, 2019;Okofo-Dartey & Kwenda, 2021) and reduces asset utilization (Abdullah, 2002;Barger et al, 2019;Okofo-Dartey & Kwenda, 2021). Free cash flow is negatively related to assets utilization and the higher the free cash flow, the efficiency of assets utilization is significantly reduced (Iskandar et al, 2012;Yero et al, 2021). Previous studies generally revealed that an increase in free cash flow can lead to higher agency costs and a decrease in asset utilization.…”

“…Previous research showed different results in examining the mediating effect of foreign ownership in strengthening the effect of net profit margin on assets utilization. Some have found that asset utilization is significantly affected by foreign ownership (Iskandar et al, 2012;Yero et al, 2021). Foreign ownership is related to assets utilization but not significant (Iskandar et al, 2012).…”

“…The negative relationship between FCF and asset utilization can be reduced by foreign ownership and high levels of foreign ownership, because it can bring additional capital and resources and cause changes in decision making (Iskandar et al, 2012). In addition, the negative relationship between free cash flow and asset utilization can be lessened with foreign ownership and high foreign the negative relationship between asset utilization and free cash flow can be weakened by high foreign ownership (Iskandar et al, 2012;Yero et al, 2021). Accordingly, the fourth hypothesis was proposed as follows:…”