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AbdulNafeaAlZararee,AbdulrahmanAl-Azzawi
theproductioncapacityoffirm)minusdividends(whichareneededtomaintainthe
necessarypayoutonthecommonstockandtocoveranypreferredstockobligation).
TheconceptofFCFforcesastockanalystorabankernotonlytoconsiderhow
muchcashisgeneratedfromoperationactivities,butalsotosubtractthenecessary
capitalexpendituresfromplantandequipmenttomaintainnormalactivitiessimilar
toeachother.Atthesametimedividendpaymentstoshareholdersmustbesubtrac-
tedasthesedividendsmustgenerallybepaidtokeepshareholderssatisfied.The
balanceofFCFisavailableforspecialfinancingactivitieswhichhaveoftenbeen
anequivalenttoleveragebuyouts,inwhichafirmborrowsmoneytobuyitsstock
andtotakeitsprivateswiththehopeofrestructuringitsbalancesheetandperhaps
goingpublicagaininafewyearsathigherpricethanitispaid[Block,Hirt1994].An
analystorabankernormallylooksatFCFtodeterminewhethertherearesufficient
excessfundstopaybacktheloanassociatedwiththeleveragepayout.
TheFCFhypothesisadvancedbyJensen[1988]statesthatmanagersattachedto
FCFwillinvestinnegativenetpresentvalue(NPV)projectsratherthanpayitoutto
shareholders.JensendefinesFCFascashflowleftafterthefirmhasinvestedinall
availablepositiveNPVprojects[Lang,Stulz,Walkiling2009].
TheFCFandfirm’sinvestmentopportunitiescanbeimportantwhenassessing
thestockmarketresponsetothefirm’sannouncementsofcorporateinvestmentdeci-
sions.Manyauthorsshowthatcorporateinvestmentsoffirmswithgoodinvestment
opportunitiesaregenerallyworthwhilewhilethosefirmswithpoorinvestmentop-
portunitiesmaybewasteful.Incontrast,Jensen’s[1986]FCFtheory,whichpredicts
differentialmarketresponsetocorporateinvestmentannouncementsdependingon
thefirm’slevelofFCF,hasmixedsupport[Chen,Chung2001].
MintonandSchrand[1999]showthathighercashflowvolatilityisassociated
withloweraveragelevelsofinvestmentincapitalexpenditures(R&Dandadverti-
sing).Thisassociationsuggeststhatthefirmsdonotuseexternalcapitalmarketsto
fullycovercashflowshortfallsbutratherpermanentlyforgoinvestment.Guiand
Tsui(1998)alsoexaminetheassociationbetweenFCFandmarketidentifiedby
Jensen[1986]assourcesofagencyproblemsforlowgrowthfirms;FCFisdefined
asthecashflowinexcessofthatanditisrequiredtofundpositive-net-present-value
projectthatisnotpaidoutindividendsAccordingtoJensen[1986;1989],managers
oflowgrowth/highFCFfirmsareinvolvedinnon-value-maximizingactivities.
Moreimportantly,theinteractionbetweenFCFanddebtissignificantintheredirec-
teddirection.Jensen[1986;1989]alsodebatedthatsomelowgrowth/highFCFof
thefirmsissuedebtrestricttheFCFfirmproblem.
TherearemanymodelstocalculatetheimpactofFCFonthecompanyvaluefor
instanceoperatingcashflow=operatingprofit-investmentandFCFonAssets=
INC-Tax-INTExp-PreDividend-OrDiv/Assets).
ThispapertriestoexaminetherelationbetweenFCFtoEquityandmarketvalue
ofthefirm.DataiscollectedforHikmafirmwhichislistedontheAmmanStock
Exchange(ASE)andLondonStockExchange(LSE)fortheperiodof2004-2010.
