Stakeholder Orientation, Agency Problems of Free Cash Flow, and the Cost of Equity: Evidence from a Natural Experiment

AbstractIn this paper, we examine the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow (FCF) on this effect. We find that firms with strong shareholder rights have a significantly lower implied cost of equity after controlling for risk factors, price momentum, analysts’ forecast biases, and industry and year effects than do firms with weak shareholder rights. Further analysis shows that the effect of shareholder rights on reducing the cost of equity is significantly stronger for firms with more severe agency problems from FCFs.

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Valuing Coca-Cola Using The Free Cash Flow To Equity Valuation Model

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v10i11.7362 ◽

2012 ◽

Vol 10 (11) ◽

pp. 629

Author(s):

John C. Gardner ◽

Carl B. McGowan, Jr ◽

Susan E. Moeller

Keyword(s):

Cash Flow ◽

Normal Growth ◽

Free Cash Flow ◽

Equity Valuation ◽

Cost Of Equity ◽

Font Size ◽

Valuation Model ◽

A Value ◽

Equity Model ◽

The Cost

In this paper, we provide a detailed example of applying the free cash flow to equity valuation model proposed in Damodaran (2006). Damodaran (2006) argues that the value of a stock is the discounted present value of the future free cash flow to equity discounted at the cost of equity. We combine the free cash flow to equity model with the super-normal growth model to determine the current value of Coca-Cola. At the time of this paper, we determined a value of Coca-Cola at $161 billion using the free cash flow to equity model, and the actual market value of Coca-Cola was $150 billion.

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Over-Valuation: Avoid Double Counting when Retaining Dividends in the FCFE Valuation

International Journal of Financial Research ◽

10.5430/ijfr.v8n4p107 ◽

2017 ◽

Vol 8 (4) ◽

pp. 107

Author(s):

Joao Marques Silva ◽

Jose Azevedo Pereira

Keyword(s):

Cash Flow ◽

Flow Model ◽

Weighted Average ◽

Free Cash Flow ◽

Double Counting ◽

Cost Of Equity ◽

Discounted Cash Flow ◽

Enterprise Valuation ◽

A Value ◽

The Cost

Valuation based on DCF (Discounted Cash Flow) has been the dominant valuation procedure during the last decades. In spite of this dominance, enterprise valuation using the discounted FCF (Free Cash Flow) model has some practical drawbacks, since there is often some confusion on how to effectively use it. Commonly, the valuation procedures start by estimating future FCF figures from historical data, such as mean FCF, growth and retention ratio, alongside many other variables. These FCF forecasts are discounted at the cost of equity (FCFE – FCF to Equity) or the Weighted Average Cost of Capital WACC (FCFF – FCF to Firm). Implicit in the above mentioned valuation procedures is the expectation that the company puts the retained free cash that is generating to good use, yielding a value capable of rewarding appropriately the level of risk inherent in the way it used. Some poorly performed valuation studies however tend to double count (Damodaran, 2006a) the retained cash’s interest in subsequent values of FCF, or include the accumulated cash build-up in the Terminal Value. This paper discusses how these two common double-counting mistakes are made and evaluates their weight in the final valuation figure for the particular case of retained FCFE (the case for the FCFF is analogous, but we focus on FCFE for simplicity) using projected figures.

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Financial Constraints and Cost of Equity: Empirical Study of Shariah Compliant Firms in Indonesia

Research in World Economy ◽

10.5430/rwe.v10n3p371 ◽

2019 ◽

Vol 10 (3) ◽

pp. 371

Author(s):

Diana Hashim Syarif ◽

Sugeng Wahyudi ◽

Irene Rini Demi Pangestuti

Keyword(s):

Cash Flow ◽

Financial Constraints ◽

Equity Capital ◽

Free Cash Flow ◽

Investment Efficiency ◽

Cost Of Equity Capital ◽

Cost Of Equity ◽

Capital Costs ◽

Financial Characteristics ◽

The Cost

This study is to investigate the relationship between financial characteristics and the cost of equity capital from sharia-based companies, which tend to be financially constrained. Using 276 observations, the results of this study indicate that financial constraints which are proxied by free cash flow have a role in influencing the cost of equity capital. This study also builds an indirect relationship of free cash flow and capital costs by proposing investment efficiency as a mediator variable. By using the causal step approach from Baron and Kenny, the test results show that investment efficiency mediates the effect of free cash flow on the cost of equity capital with an indirect effect that is stronger than the direct effect. This study also found evidence that leverage has no role in strengthening the effect of free cash flow on the cost of equity capital.

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Dead Hand Proxy Puts and Hedge Fund Activism

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109018001424 ◽

2018 ◽

Vol 54 (4) ◽

pp. 1615-1642

Author(s):

Sean J. Griffith ◽

Natalia Reisel

Keyword(s):

Cash Flow ◽

Hedge Fund ◽

Cost Benefit ◽

Free Cash Flow ◽

Cross Sectional ◽

Flow Problems ◽

Banking Relationships ◽

Hedge Fund Activism ◽

The Cost ◽

Sectional Analysis

We investigate the Dead Hand Proxy Put, a contractual innovation in corporate debt agreements that may impact hedge fund activism. We find the provision principally in loans, not bonds, and provide evidence linking the adoption of the provision to hedge fund activism. Furthermore, controlling for endogeneity, we find that the provision significantly reduces the cost of loans. Bondholder wealth also increases. Moreover, cross-sectional analysis of share returns reveals that the provision is positively associated with repeat banking relationships and negatively associated with free cash flow problems, suggesting a cost-benefit tradeoff.

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Degree of free cash flow leverage

Review of Accounting and Finance ◽

10.1108/raf-03-2018-0061 ◽

2019 ◽

Vol 18 (3) ◽

pp. 346-365 ◽

Cited By ~ 1

Author(s):

David Yecham Aharon ◽

Yoram Kroll ◽

Sivan Riff

Keyword(s):

Cash Flow ◽

Capital Expenditure ◽

Risk Measure ◽

Efficient Frontier ◽

Optimal Level ◽

Free Cash Flow ◽

Content Type ◽

Optimal Output ◽

The Cost ◽

The Impact

Purpose This paper aims to forgo the conventional (degree of operating leverage) risk measure by replacing elasticity of operating profits with respect to output with elasticity of free cash flow (FCF) with respect to optimal output and by considering exogenous random demand shocks for the firm’s products as a source of risk. Design/methodology/approach The elasticity risk measure accounts for corporate taxes and the cost of bankruptcy. The methodology is selecting optimal level of production investment and capital structure to generate efficient frontier of expected FCF and its risk in terms of its elasticity with respect to output. Findings The risk measure leads to efficient frontier between expected FCF and its idiosyncratic managerial risk. The model also resolves the empirical debate on the tradeoff between operating and financial leverages. Originality/value It is the first elasticity risk measure that embodied the impact of future level of capital expenditure, total level of assets and their sensitivity to random shocks in the product market.

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The Corporate Life Cycle and the Cost of Equity

Journal of Business Valuation and Economic Loss Analysis ◽

10.1515/jbvela-2018-0009 ◽

2019 ◽

Vol 14 (1) ◽

Cited By ~ 2

Author(s):

Sergio Bravo

Keyword(s):

Life Cycle ◽

Cash Flow ◽

Cost Of Capital ◽

Theory And Practice ◽

Cost Of Equity ◽

Firm Life Cycle ◽

Link Type ◽

Life Cycle Stages ◽

Corporate Life Cycle ◽

The Cost

Abstract A widely used methodology for estimating the beta of companies with the Capital Asset Pricing Model (CAPM) uses comparable firms based only on industry or sector classifications (Bancel, F., and U. R. Mittoo. 2014. “The Gap between the Theory and Practice of Corporate Valuation: Survey of European Experts.” Journal of Applied Corporate Finance 26, no. 4 (Fall): 106–17. doi:https://doi.org/10.1111/jacf.12095, 112; KPMG. 2017. “Cost of Capital Study 2017: Diverging Markets, Converging Business Models.” Accessed September 28, 2018. https://assets.kpmg.com/content/dam/kpmg/ch/pdf/cost-of-capital-study-2017-en.pdf, 37). We hypothesize that even within industries, there is a significant relationship between the cost of equity and the life cycle of a firm. We argue that these variables are correlated because different life-cycle stages exhibit different degrees of systematic risk. Therefore, as the firm moves along its life cycle, its unlevered beta decreases. We define the stages of the firm life cycle based on a modification of the theoretical typology of (Miller, D., and P. Friesen. 1984. “A Longitudinal Study of the Corporate Life-Cycle.” Management Sciences 30 (10): 1161–83. http://www.jstor.org/stable/2631384, 1162–3) and then classify a sample of listed companies into these stages using (Dickinson, V. 2011. “Cash Flow Patterns as a Proxy for Firm Life-Cycle.” The Accounting Review 86 (6): 1969–94. doi:https://doi.org/10.2308/accr-10130) cash flow statements methodology. We construct value-weighted portfolios that are formed based on our life-cycle stages classification, adapting the procedure of (Fama, E., and K. R. French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33 (1): 3–56. doi:https://doi.org/10.1016/0304-405X(93)90023-5). Finally, we compare the betas (levered and unlevered) of these portfolios to determine whether there are statistically significant differences. Our results show clear evidence of a relationship between betas and the corporate life cycle and that this relationship is robust to both changes in the period of analysis and omitted variables bias (when controlling with the four-factor model of (Carhart, M. M. 1997. “On Persistence in Mutual Fund Performance.” The Journal of Finance 52 (1): 57–82. doi:https://doi.org/10.1111/j.1540-6261.1997.tb03808.x). We believe our results show an important shortcoming in a widely used methodology among practitioners for estimating the CAPM.

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Corporate social responsibility disclosure and the cost of equity capital: The roles of stakeholder orientation and financial transparency

Journal of Accounting and Public Policy ◽

10.1016/j.jaccpubpol.2014.04.006 ◽

2014 ◽

Vol 33 (4) ◽

pp. 328-355 ◽

Cited By ~ 190

Author(s):

Dan Dhaliwal ◽

Oliver Zhen Li ◽

Albert Tsang ◽

Yong George Yang

Keyword(s):

Corporate Social Responsibility ◽

Social Responsibility ◽

Equity Capital ◽

Cost Of Equity Capital ◽

Cost Of Equity ◽

Stakeholder Orientation ◽

Corporate Social Responsibility Disclosure ◽

Financial Transparency ◽

Corporate Social ◽

The Cost

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Agency problems and audit fees: further tests of the free cash flow hypothesis

Accounting and Finance ◽

10.1111/j.1467-629x.2009.00327.x ◽

2009 ◽

Vol 50 (2) ◽

pp. 321-350 ◽

Cited By ~ 20

Author(s):

Paul A. Griffin ◽

David H. Lont ◽

Yuan Sun

Keyword(s):

Cash Flow ◽

Agency Problems ◽

Audit Fees ◽

Free Cash Flow ◽

Free Cash Flow Hypothesis

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Voluntary disclosure and free cash flow in family French firms

Corporate Ownership and Control ◽

10.22495/cocv17i4siart15 ◽

2020 ◽

Vol 17 (4, Special Issue) ◽

pp. 391-398

Author(s):

Meriem Jouirou ◽

Faten Lakhal

Keyword(s):

Cash Flow ◽

Voluntary Disclosure ◽

Audit Committee ◽

Family Firms ◽

Gender Diversity ◽

Agency Problems ◽

Free Cash Flow ◽

Governance Mechanisms ◽

Voluntary Disclosures

This research investigates the governance role of voluntary disclosures especially in reducing agency problems measured by the level of free cash flow (FCF). In addition, it also shows the moderating effect of family ownership and governance mechanisms on this relation. Our research was conducted on a sample of 138 listed French firms between 2009 and 2013. To avoid the endogeneity problem caused by the voluntary disclosure variable we used the 2SLS regression method. The results show, on the one hand, that transparency provided by voluntary disclosures reduces the level of FCF and by the way agency problems. But family owners tend to accumulate FCF. On the other hand, the governance role of voluntary disclosure turns to be ineffective in family firms. This suggests a high risk of expropriation of minority shareholders by family ones. In addition, we demonstrate that governance mechanisms, especially board independence, gender diversity and audit committee independence, contribute to the strengthening of the governance role of voluntary disclosure.

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