The Relationship Between Investment and Free Cash Flow: Evidence From New Zealand Firms

Zhu, Xi
Yang, Ting
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Master of Business
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Auckland University of Technology

Free cash flow plays an important role in explaining firms’ investment activities. The aim of this Master dissertation is to determine whether and how free cash flow affect firm-level investments in New Zealand (NZ) listed companies. To investigate and interpret the relationship between firms’ investment decisions in present of free cash flow, this study process in three parts. The first part aims to determine whether there exists a relationship between a firm’s level of investment and its level of internally generated cash flow. The second part intends to examine the association between firm-level overinvestments and free cash flows. The third part proposes to investigate the impact of corporate governance factors on overinvestment-FCF sensitivity.

Based on the methods from previous studies, this study analyzes the data from 63 New Zealand listed firms on the New Zealand Stock Market between financial year (FY) 2004 to FY2018. Consistent with prior literature (Alti, 2003; Hubbard, 1998; Vogt,1997), this study discovers that NZ companies’ investment expenditures are positively related to their internal funds. Similar to previous studies on U.S. data (Richardson, 2006), the results in this study indicate that the firms’ over-investment is positively connected with positive free cash flow. Specifically, overinvestment activities are more pronounced in companies with positive free cash flows. Moreover, this study finds that certain corporate governance characteristics, such as insider-dominated ownership composition and small board size, are significantly and positively related to overinvestment-FCF sensitivity. This study further divides the full sample into two subsamples: over-investment firms and under-investment firms. For over-investment firms, the evidence indicates that firms with larger board size, higher percentage of independent directors on the board, higher leverage, or large firm size are less likely to experience over-investment. For under-investment firms, the findings show that larger board size can boost the under-investment issue, while concentrated ownership, higher proportion of independent directors on the board, higher leverage, or large firm size can mitigate it.

Internally generated cash flow , Firm-level investment , Free cash flow , Over-investment , Corporate governance , New Zealand
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