An Empirical Test On The Debt Monitoring Of The Hypothesis Of Free Cash Flow

The hypothesis of free cash flow (FCF) said, to a company not only indulged in low-growth but also had too much FCF, it was much possible for the managers to use these cash in some suboptimal projects or private consumption, so the agency problem of FCF emerged. The hypothesis also gave the solution——'debt monitoring', debt can monitor and reduce this kind of agency costs, because the pressure of repay for the debt can restrain the managers'tendency to misuse the cash resource. Firstly, some research papers and our statistics had found the existence of agency problem of FCF in Chinese listed companies, so did they use 'debt monitoring'to control the agency costs? It was the first starting point of this paper. Secondly, in China, debt was usually seen as an essential reason that resulted in inefficiency in companies, many problems in economy were connected with high debt ratio, then did debt have not any merits? If the answer was no, what were its good impact and effect, especially on reducing agency costs? To dig the merit of debt is the other starting point of this paper. The framework of this paper was divided into three parts. Part 1 included Chapter 2 and Chapter 3. Chapter 2 was the theoretical background, emphasized on the introduction of hypothesis of FCF and the debt monitoring; Chapter 3 was the reality background in China. The second part, Chapter 4, was the nuclear of this paper, we proposed the "debt monitoring"and other three relevant hypotheses, then set three models respectively with total debt, short-term debt and long-term debt as dependent variable and FCF as the most important independent variable, divided the sample into two panels according to the growth or the firm size, and tested the hypothesis via debt monitoring. The last part was Chapter 5 about the strategy and suggestion,and the chapter 6 about the research conclusion, the limitations and the future research ideas. The test results of this paper were: ①the low-growth companies supported the debt monitoring hypothesis; ②the high-growth companies didn't show the evidence to indirectly support the hypothesis; ③the paper didn't find the evidence that the debt monitoring was only used by big firms, but not by small firms; ④the hypothesis about the substitution between debt and cash dividend was supported only in low-growth & big-size companies. Total in all, the first and the last results supported the hypothesis of FCF via 'debt monitoring'. In the end, the paper gave the suggestions and future ideas.