Impact of Free Cash Flow (FCF) on Firm Performance: Evidence from Pakistan
Abstract
According to free cash flow (FCF) theory, there is a negative correlation between a manager's restriction of FCF and company performance. It suggests that dividend payouts and debt financing tend to decrease the FCF, resulting in enhanced company performance. To examine this hypothesis, a study was conducted in Pakistan that focused on non-financial companies listed on the Pakistan Stock Exchange PSX. The research employed stratified sampling technique by selecting 28 companies. Data was collected from the time period 2013-2017. The data obtained from the State Bank of Pakistan (SBP) and financial statements from company websites served as primary sources. The study considered variables, that is, FCF, dividend per share, leverage (LEV) (as independent variables), return on assets (ROA) (as the dependent variable), and capital liquidity along with firm size (as control variables). Panel regression analysis utilizing EViews was used for data analysis. Findings showed that both FCF and dividend payouts have a significant and positive impact on firm performance, while LEV does not exert a significant effect. Moreover, firm size was identified as having a significant negative impact on firm performance. The outcomes of the current study hold potential value for both foreign and local investors as well as for companies aiming to establish robust dividend policies.
Downloads
References
Abbas, F., Ali, S., & Ahmad, M. (2023). Does economic growth affect the relationship between banks' capital, liquidity and profitability: Empirical evidence from emerging economies. Journal of Economic and Administrative Sciences, 39(2), 366–381. https://doi.org/10.1108/JEAS-03-2021-0056
Abeywardhana, D. K. Y. (2017). Capital structure theory: An overview. Accounting And Finance Research, 6(1), 133–138. https://doi.org/10.5430/afr.v6n1p133
Afinindy, I., Salim, U., & Ratnawati, K. (2021). The effect of profitability, firm size, liquidity, sales growth on firm value mediated capital structure. International Journal of Business, Economics and Law, 24(4), 15–22.
Ahmed, F., Rahman, M. U., Rehman, H. M., Imran, M., Dunay, A., & Hossain, M. B. (2024). Corporate capital structure effects on corporate performance pursuing a strategy of innovation in manufacturing companies. Heliyon, 10(3), Article eE24677. https://doi.org/10.1016/j.heliyon.2024.e24677
Ali, M. (2020). Impact of leverage on financial performance (evidence from Pakistan food and fertilizer sector). Journal of Critical Reviews, 7(13), 447–456.
Almeida, H., Campello, M., & Weisbach, M. S. (2004). The cash flow sensitivity of cash. The Journal of Finance, 59(4), 1777–1804.
Al-Zararee, A., & Al-Azzawi, A. (2014). The impact of free cash flow on market value of firm. Global Review of Accounting and Finance, 5(2), 56–63. https://doi.org/10.21102/graf.2014.09.52.04
Angela, A., Hidayat, V., & Eunike, E. (2023). Working capital management, free cash flow, profitability and firm value. Proaction Journal, 10(2), 172–181. https://doi.org/10.32534/jpk.v10i2.3980
Asad, M., & Yousaf, S. (2014). Impact of leverage on dividend payment behavior of Pakistani manufacturing firms. International Journal of Innovation and Applied Studies, 6(2), 216–221.
Benson, E., & Odey, J. O. (2022). Net cash flow from operating activities and liquidity of First Bank Nigeria Plc. World Scientific News, 168, 1–15.
Bhandari, L., Dasgupta, S., & Gangopadhyay, S. (2003). Development financial institutions, financial constraints and growth: evidence from the Indian corporate sector. Journal of Emerging Market Finance, 2(1), 83–121.
https://doi.org/10.1177/097265270300200104
Bissoondoyal-Bheenick, E., Brooks, R., & Do, H. X. (2023). ESG and firm performance: The role of size and media channels. Economic Modelling, 121, Article e106203. https://doi.org/10.1016/j.econmod.2023.106203
Brush, T. H., Bromiley, P., & Hendrickx, M. (2000). The free cash flow hypothesis for sales growth and firm performance. Strategic Management Journal, 21(4), 455–472. https://doi.org/10.1002/(SICI)1097-0266(200004)21:4<455::AID-SMJ83>3.0.CO;2-P
Campello, M., Giambona, E., Graham, J. R., & Harvey, C. R. (2011). Liquidity management and corporate investment during a financial crisis. The Review of Financial Studies, 24(6), 1944–1979. https://doi.org/10.1093/rfs/hhq131
Carracedo, P., Puertas, R., & Marti, L. (2021). Research lines on the impact of the COVID-19 pandemic on business. A text mining analysis. Journal of Business Research, 132, 586–593. https://doi.org/10.1016/j.jbusres.2020.11.043
Chung, R., Firth, M., & Kim, J. B. (2005). Earnings management, surplus free cash flow, and external monitoring. Journal of Business Research, 58(6), 766–776. https://doi.org/10.1016/j.jbusres.2003.12.002
De Miguel, A., & Pindado, J. (2001). Determinants of capital structure: New evidence from Spanish panel data. Journal of Corporate Finance, 7(1), 77–99. https://doi.org/10.1016/S0929-1199(00)00020-1
Dewi, I., Sari, M., Budiasih, I., & Suprasto, H. (2019). Free cash flow effect towards firm value. International Research Journal of Management, IT and Social Sciences, 6(3), 108–116. https://doi.org/10.21744/IRJMIS.V6N3.643
Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74(366), 427–431. https://doi.org/10.2307/2286348
Ebaid, I. E.-S. (2009). The impact of capital‐structure choice on firm performance: Empirical evidence from Egypt. The Journal of Risk Finance, 10(5), 477–487. https://doi.org/10.1108/1526594091100138
Eklesiawati, E., & Novyarni, N. (2020). The effect of free cash flow, liquidity and leverage on payout ratio dividends in manufacturing companies listed in Indonesia stock exchange period 2014 – 2019. Repository Stie (Stei) Jakarta. http://repository.stei.ac.id/1089/
Enow, S. (2023). Capital structure on dividend policy: Is there any relationship? International Journal of Economics and Financial Issues, 13(3), 141–144. https://doi.org/10.32479/ijefi.14344
Farhan, N. H., Almaqtari, F. A., Hazaea, S. A., & Al-Ahdal, W. M. (2023). The moderating effect of liquidity on the relationship between sustainability and firms' specifics: Empirical evidence from indian manufacturing sector. Heliyon, 9(4), Article eE15439. https://doi.org/10.1016/j.heliyon.2023.e15439
Fosberg, R. H., & Ghosh, A. (2006). Profitability and capital structure of Amex and Nyse firms. Journal of Business & Economic Research, 4(11), 57–64
Gul, F. A., & Tsui, J. S. L. (1997). A test of the free cash flow and debt monitoring hypotheses: Evidence from audit pricing. Journal of Accounting and Economics, 24(2), 219–237. https://doi.org/10.1016/S0165-4101(98)00006-8
Hasibuan, D. H., & Khomsiyah, E. (2019). Do corporate social responsibility and corporate governance affect tax aggressiveness? Evidence from Indonesia. Journal of Accounting, Business and Finance Research, 7(1), 8–16.
https://doi.org/10.20448/2002.71.8.16
Hendrianto, S. (2022). Analysis of return on equity, dividend payout ratio, price to earning ratio and their influence on stock returns in LQ45 companies listed on the Indonesia stock exchange. Journal Multidisiplin Madani, 2(4), 1915–1928. https://doi.org/10.55927/mudima.v2i4.284
Heydari, I., Mirzaeifar, M., & Javadghayedi, M. (2014). Investigating the relationship between free cash flows and firm performance: Evidence from Tehran Stock Exchange. Indian Journal of Scientific Research, 4(6), 269–279.
Heydari, S. (2014). An investigation about the information content of earnings and cash-flows in anticipating of liquidity position of listed companies in tehran stock exchanges. Kuwait Chapter of Arabian Journal of Business and Management Review, 3(6), 175–182. https://doi.org/10.12816/0018190
Im, K. S., Pesaran, M. H., & Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of Econometrics, 115(1), 53–74. https://doi.org/10.1016/S0304-4076(03)00092-7
Iskandar, T. M., Bukit, R. B., & Sanusi, Z. M. (2012). The moderating effect of ownership structure on the relationship between free cash flow and asset utilisation. Asian Academy of Management Journal of Accounting & Finance, 8(1), 69–89.
Jaggi, B., Gul, F. A., & Lau, T. S. C. (2012). Auditor industry specialization, political economy and earnings quality: Some cross‐country evidence. Journal of International Financial Management & Accounting, 23(1), 23–61. https://doi.org/10.1111/j.1467-646X.2011.01053.x
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance and takeovers. American Economic Review, 76(2), 323–329.
Jensen, M. C. (1993). The modern industrial revolution, exit, and the failure of internal control systems. The Journal of Finance, 48(3), 831–800. https://doi.org/10.1111/j.1540-6261.1993.tb04022.x
Jouini, F. (2022). The moderating role of firm size on leverage-performance association: case of the peripheral countries of the Eurozone. Studies of Applied Economics, 40(3). https://doi.org/10.25115/eea.v40i3.7036
Kadioglu, E., & Yilmaz, E. A. (2017). Is the free cash flow hypothesis valid in Turkey? Borsa Istanbul Review, 17(2), 111–116. https://doi.org/10.1016/j.bir.2016.12.001
Kamran, M. R., Zhao, Z., & Ambreen, S. (2017). Free cash flow impact on firm’s profitability: An empirical indication of firms listed in KSE, Pakistan. European Online Journal of Natural and Social Sciences, 6(1), 146–57. https://doi.org/10.47505/IJRSS.2022.V3.4.2
Khan, A., Kaleem, A., & Nazir, M. S. (2012). Impact of financial leverage on agency cost of free cash flow: Evidence from the manufacturing sector of Pakistan. Journal of Basic and Applied Scientific Research, 2(7), 6694–6700.
Khan, M. N., Naeem, M. U., Rizwan, M., & Salman, M. (2016). Factors affecting the firm dividend policy: An empirical evidence from textile sector of Pakistan. International Journal of Advanced Scientific Research and Management, 1(5), 144–149.
Khidmat, W. B., & Rehman, M. (2014). Impact of liquidity & solvency on profitability chemical sector of Pakistan. Economics Management Innovation, 6(3), 34–67.
Kutty, G. (2010). Venture capital funds: The relationship between exchange rates and stock prices: The case of Mexico. Journal of Banking & Finance, 4, 1–13. https://doi.org/10.1016/j.jbankfin.2009.08.022
Lehn, K., & Poulsen, A. (1989). Free cash flow and stockholder gains in going private transactions. the Journal of Finance, 44(3), 771–787. https://doi.org/10.1111/j.1540-6261.1989.tb04390.x
Levin, A., Lin, C.-F., & Chu, C.-S. J. (2002). Unit root tests in panel data: Asymptotic and finite-sample properties. Journal of Econometrics, 108(1), 1–24. https://doi.org/10.1016/S0304-4076(01)00098-7
Lin, W. L., Ho, J. A., Sambasivan, M., Yip, N., & Mohamed, A. B. (2021). Influence of green innovation strategy on brand value: The role of marketing capability and R&D intensity. Technological Forecasting and Social Change, 171, Article e120946. https://doi.org/10.1016/j.techfore.2021.120946
Lisa, H., & Zuraida, Z. (2023). Dividend payout ratio, free cash flow, and share repurchases in Indonesian listed companies. Journal of Accounting and Business, 23(1), 139–156. https://doi.org/10.20961/jab.v23i1.1017
Lohonauman, H., & Budiarso, N. S. (2021). The effect of free cash flow and profitability on dividend payout ratio (case of lq-45 indexed firms in Indonesia stock exchange for period 2011-2018). Accountability, 10(1), 1–6. https://doi.org/10.32400/ja.32071.10.1.2021.1-6
Magdalena, S. M., & Tjahjono, R. S. (2022). Entity performance, debt policy and share ownership on company value. E-Jurnal Akuntansi TSM, 2(4), 489–502. https://doi.org/10.34208/ejatsm.v2i4.1818
Mansourlakoraj, R., & Sepasi, S. (2015). Free cash flow, capital structure and the value of listed companies in Tehran stock exchange. International Journal of Management, Accounting and Economics, 2(2), 144–148.
Meng, Q., Li, X., Chan, K. C., & Gao, S. (2020). Does short selling affect a firm's financial constraints? Journal of Corporate Finance, 60, Article e101531. https://doi.org/10.1016/j.jcorpfin.2019.101531
Morley, J. (2014). The separation of funds and managers: A theory of investment fund structure and regulation. Yale Law Journal, 123(5), 1228–1287. https://doi.org/10.2139/ssrn.2240468
Muriungi, A., & Mwangi, M. (2020). Dividend theory and empirical evidence: A theoretical perspective. Journal of Accounting Finance and Auditing Studies, 6(3), 120–134. https://doi.org/10.32602/jafas.2020.020
Na, S. (2018). The free cash flow and corporate returns [Master thesis, Utah State University]. Utah State University: University Libraries. https://digitalcommons.usu.edu/gradreports/1347/
Nofitasari, S., & Gunarsih, T. (2022). Are managerial ownership and financial performance affect dividend policy? International Journal of Economics, Business and Management Research, 6(10), 108–124. https://doi.org/10.51505/ijebmr.2022.61007
Nunez, K. (2013). Free cash flow and performance predictability in electric utilities. Journal of Business and Policy Research, 8(1), 19–38.
Nunez, K. (2014). Free cash flow and performance predictability: An industry analysis. International Journal of Business, Accounting, & Finance, 8(2), 120–135.
Nur, T. (2023). The nexus between corporate investment decisions and firm profitability: Moderating role of cash flows and investment opportunities. Muhasebe ve Finansman Dergisi, 98, 171–188. https://doi.org/10.25095/mufad.1244004
Nurdani, R., & Rahmawati, I. Y. (2020). The effect of firm sizes, profitability, dividend policy, asset structure, sales growth and free cash flow on debt policy. Andalas Management Review, 4(1), 100–119. https://doi.org/10.25077/amar.4.1.100-119.2020
Ozdemir, O., Erkmen, E., & Binesh, F. (2022). Board diversity and firm risk-taking in the tourism sector: Moderating effects of board independence, CEO duality, and free cash flows. Tourism Economics, 28(7), 1782–1804. https://doi.org/10.1177/13548166211014367
Park, K., & Jang, S. (2013). Effects of within-industry diversification and related diversification strategies on firm performance. International Journal of Hospitality Management, 34, 51–60. https://doi.org/10.1016/j.ijhm.2013.02.009
Pindado, J., & De La Torre, C. (2009). Effect of ownership structure on underinvestment and overinvestment: empirical evidence from Spain. Accounting & Finance, 49(2), 363–383. https://doi.org/10.1111/j.1467-629X.2008.00286.x
Prakoso, S. W. R., & Muchtar, S. (2023). Factors that influence dividend payout ratio in non-financial companies. Jurnal Bisnis Dan Akuntansi, 19(2), 285–299. https://doi.org/10.34208/jba.v19i2.280
Putri, D. A. K., & Azzahra, K. (2022). The effect of free cash flow, investment opportunity set and institutional ownership on dividend policy. Journal Of Management, Accounting, General Finance and International Economic Issues, 1(4), 155–168.
https://doi.org/10.55047/marginal.v1i4.312
Rahman, A. F., & Saleh, N. M. (2008). The effect of free cash flow agency problem on the value relevance of earnings and book value. Journal of Financial Reporting and Accounting, 6, 75–90. https://doi.org/10.1108/19852510880000636
Randika, D. (2022). Effect of financial leverage on firm performance: Reference to investment trust companies listed in Sri Lanka. International Journal of Research in Social Science and Humanities, 3(4), 17–25. https://doi.org/10.47505/IJRSS.2022.V3.4.2
Rifai, M., Wiyono, G., & Sari, P. P. (2022). Pengaruh profitabilitas, leverage, dan investment opportunity set (ios) terhadap kebijakan dividen pada perusahaan sektor consumer good yang terdaftar di bursa efek Indonesia periode 2016-2019. Jurnal Manajemen, 14(1), 171–180. https://doi.org/10.30872/jmmn.v14i1.10884
Rizqia, D. A., Aisjah, S., & Sumiati. (2013). Effect of managerial ownership, financial leverage, profitability, firmsize, and investment opportunity on dividend policy and firm value. Research Journal of Finance and Accounting, 4(11), 120–130.
Rusmin, R., Astami, E. W., & Hartadi, B. (2014). The impact of surplus free cash flow and audit quality on earnings management: The case of growth triangle countries. Asian Review of Accounting, 22(3), 217–232. https://doi.org/10.1108/ARA-10-2013-0062
Saar, G., Sun, J., Yang, R., & Zhu, H. (2023). from market making to matchmaking: Does bank regulation harm market liquidity? The Review of Financial Studies, 36(2), 678–732. https://doi.org/10.1093/rfs/hhac068
Saleh, M. S. A. H., Ibrahim, Y., & Shahar, H. K. (2020). The simultaneous effect of corporate ownership on dividends and capital structure: Malaysian evidence. International Journal of Financial Research, 11(6), 46–62. https://doi.org/10.5430/ijfr.v11n6p46
Sapuan, N. M., Wahab, N. A., Fauzi, M. A., & Omonov, A. (2021). Analysing the impacts of free cash flow, agency cost and firm performance in public listed companies in Malaysia. Journal of Governance and Integrity, 5(1), 211–218. https://doi.org/10.15282/jgi.5.1.2021.7061
Schwoy, S., Dutzi, A., Corten, M., & Steijvers, T. (2023). Staging or real commitment? CEO reputation management as a moderator of the influence of firm size on corporate social responsibility performance and controversies. Journal of Cleaner Production, 410, Article e137325. https://doi.org/10.1016/j.jclepro.2023.137325
Tran, V. T., Lin, C. T., & Nguyen, H. (2016). Liquidity creation, regulatory capital, and bank profitability. International Review of Financial Analysis, 48, 98–109. https://doi.org/10.1016/j.irfa.2016.09.010
Trisna, I. K. E. R., & Gayatri, G. (2019). Company size moderates the effect of free cash flow and leverage on dividend policy. Udayana University Accounting E-Journal, 26(1), 484–509. https://doi.org/10.24843/EJA.2019.v26.i01.p18
Van Horne, J. C., & Wachowicz, J. M. (2008). Fundamentals of financial management (13th ed.). Financial Times/Prentice Hall.
Wang, G. Y. (2010). The impacts of free cash flows and agency costs on firm performance. Journal of Service Science and Management, 3(4), 408–418. https://doi.org/10.4236/jssm.2010.34047
Wardini, M., Anugrah, Y., & Laili, A. (2023). Capital structure and dividend policy. Muhasabatuna: Jurnal Akuntansi Syariah. http://repository.iaisyarifuddin.ac.id/id/eprint/86/
Weill, L. (2008). Leverage and corporate performance: Does institutional environment matter? Small Business Economics, 30(3), 251–265. https://doi.org/10.1007/s11187-006-9045-7
Wibowo, A., & Setiany, E. (2023). The importance of traits of board of commissioners, company size, profitability and free cash flow in affecting the dividend policy. Journal of Accounting and Finance Management, 3(6), 285–299. https://doi.org/10.38035/jafm.v3i6.168
Wu, Y., Gu, F., Ji, Y., Guo, J., & Fan, Y. (2020). Technological capability, eco-innovation performance, and cooperative R&D strategy in new energy vehicle industry: Evidence from listed companies in China. Journal of Cleaner Production, 261, Article e121157. https://doi.org/10.1016/j.jclepro.2020.121157
Yousef, H. H., & Ojah, H. K. (2022). The effect of free cash flow on the firm value in a sample of Iraqi commercial companies listed in the Iraqi stock exchange. American Journal of Business Management, Economics and Banking, 6, 20–33.
Zhu, L., Yan, M., & Bai, L. (2022). Prediction of enterprise free cash flow based on a backpropagation neural network model of the improved genetic algorithm. Information, 13(4), Article e172. https://doi.org/10.3390/info13040172
Copyright (c) 2024 Usman Hameed, Shakeel Iqbal, Dr, Bab Shah
![Creative Commons License](http://i.creativecommons.org/l/by/4.0/88x31.png)
This work is licensed under a Creative Commons Attribution 4.0 International License.
JFAR follows an open-access publishing policy and full text of all articles is available free, immediately upon acceptance. Articles are published and distributed under the terms of the Creative Commons Attribution 4.0 International License. Thus, work submitted to UMT Journals implies that it is original, unpublished work of the authors; neither published previously nor accepted/under consideration for publication elsewhere. On acceptance of a manuscript for publication, a corresponding author on the behalf of all co-authors of the manuscript will sign and submit a completed Author Consent, Copyright, and Declaration Form.