Agency Costs of Free Cash Flow
In a 1986 paper in the American Economic Review, Michael Jensen noted that free cash flows allowed firms' managers to finance projects earning low returns which therefore might not be funded by the equity or bond markets. Examining the US oil industry, which had earned substantial free cash flows in the 1970s and the early 1980s, he wrote that
1984 cash flows of the ten largest oil companies were $48.5 billion, 28 percent of the total cash flows of the top 200 firms in Dun's Business Month survey. Consistent with the agency costs of free cash flow, management did not pay out the excess resources to shareholders. Instead, the industry continued to spend heavily on activity even though average returns were below the cost of capital.
Jensen also noted a negative correlation between exploration announcements and the market valuation of these firms - the opposite effect to research announcements in other industries.
Read more about this topic: Free Cash Flow
Famous quotes containing the words agency, costs, free, cash and/or flow:
“It is possible that the telephone has been responsible for more business inefficiency than any other agency except laudanum.... In the old days when you wanted to get in touch with a man you wrote a note, sprinkled it with sand, and gave it to a man on horseback. It probably was delivered within half an hour, depending on how big a lunch the horse had had. But in these busy days of rush-rush-rush, it is sometimes a week before you can catch your man on the telephone.”
—Robert Benchley (1889–1945)
“The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.”
—Adam Smith (1723–1790)
“You have waited, you always wait, you dumb, beautiful ministers,
We receive you with free sense at last, and are insatiate
hence-forward,
Not you any more shall be able to foil us, or withhold yourselves
from us,
We use you, and do not cast you aside—we plant you permanently within us,
We fathom you not—we love you—there is perfection in you also,
You furnish your parts, toward eternity,
Great or small, you furnish your parts toward the soul.”
—Walt Whitman (1819–1892)
“The Church has always been willing to swap off treasures in heaven for cash down.”
—Robert Green Ingersoll (1833–1899)
“Flow, flow the waves hated,
Accursed, adored,
The waves of mutation:
No anchorage is.”
—Ralph Waldo Emerson (1803–1882)