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1International Journal of Economic Research
The effect of Free Cash Flow on the Companies’ Financial Polices: Evidence from Jordan
International Journal of Economic Research
ISSN : 0972-9380
available at http: www.serialsjournal.com
© Serials Publications Pvt. Ltd.
Volume 14 • Number 9 • 2017
The effect of Free Cash Flow on the Companies’ Financial Polices:
Evidence from Jordan
Musa Abdel Latif Ibrahim Alnawaiseh, Rania Mohammad Alomari,
Firas Al-Rawashdeh and Mahmoud barakat alnawaiseh
Faculty of Management and Finance, The University of Jordan, E-mail: nawayseh@ju.edu.jo
Abstract:
This study aims to examine the effect of the free cash flows (FCF) on the financial polices (the
financial leverage and the dividends) of the Jordanian industrial companies which are listed in Amman Stock
Exchange (ASE), which are 58 companies. The study is performed by surveying the financial reports of these
companies which are disclosed inASE. The study uses regression to analysis the data and to examine the
study’s hypotheses.
The study reveals that there is a significant negative effect of FCF on financial leverage, while there is insignificant
effect of FCF on dividends.
The study recommends the accounting professional members to agree on one definition of FCF to
help researches and to make the comparison between companies easy, the companies to disclose in their
reports as the requirements of IFRS 1, and to ask these companies to disclose FCF in their financial
reports.
Key words:
free cash flow, leverage, dividend.
INTRODUCTION
Free cash flow is used to pay dividends, to repay debt and interest payable to creditors or lenders, to
repurchase the company’s shares, to purchase new investments and to purchase new assets. Some time the
increase of these flows may not be in benefit of the company, especially when managers fail to use these
flows to increase the owners’ wealth, after that the conflict between the owners’ interests and managers’
interests may be appeared, and the agency problems appear and .
Because of the importance of free cash flow analysis, many countries start to ask companies to do
this analysis and enclose it in their financial reports, such as in the United States.
International Journal of Economic Research 2
Musa Abdel Latif Ibrahim Alnawaiseh, Rania Mohammad Alomari, Firas Al-Rawashdeh & Mahmoud barakat alnawaiseh
The studies that investigated the relationship between FCF and the financial indicators increased in
developed countries, but such studies came late in undeveloped countries that need these kinds of studies.
The management of the company which has allegiance to its enterprise trays to enhance the company’s
position, chooses the productive investments, increases the owner’s equity, pays the company’s debts without
liquidating assets, pays declared dividends, if it has FCF. So it should analysis the relationships between
FCF and the financial ratios, because it gives an integrated picture of the company, helps in evaluating the
company’s performance accurately.
This study examined the effect on free cash flow on the financial leverage and dividend payout in the
Jordanian industrial companies which is listed on Amman Financial Market, based on the data available for
these companies in this market.
THE STUDY PROBLEM
A lot of industrial companies in Jordan are profitable units, this is followed by emergence of surplus cash
flows, but a few of them announced a dividend regularly, this will effect on numbers of the investors, who
like to invest in them, hence, this study try to answer the following questions:
Question 1: Is there a statistically significant effect of the free cash flows on the financial leverage of
the Jordanian industrial companies listed in the ASM?
Question 2: Is there a statistically significant effect of free cash flows on the dividend of the Jordanian
industrial companies listed on the ASM?
THE IMPORTANCE OF THE STUDY AND ITS OBJECTIVES
The study aims to track the impact of free cash flow on the financial leverage and the dividends payout,
as a first study in this field in Jordan. The study aims to answer questions the study and testing of
hypotheses.
THE STUDY HYPOTHESES
The study aims to test following hypotheses:
H01: There is no statistically significant of free cash flows on the financial leverage in the Jordanian
industrial companies listed in ASM.
H02: There is no statistically significant of free cash flows on the dividends payout of the Jordanian
industrial companies listed in ASM.
THE STUDY LIMITATIONS
After surveying the previous studies in the study’s field and collecting the study’s data, researcher faced the
following limitations:
– The number of industrial companies is not enough to help researcher to achieve better result
– The difficulty of obtaining the financial data directly from the companies.
3International Journal of Economic Research
The effect of Free Cash Flow on the Companies’ Financial Polices: Evidence from Jordan
LITERATURE REVIEW
There are a lot of FCF definitions. Utami and Inanga (2011) defines FCF as it is the net income minus
changes in fixed and changes of assets in net working capital divided by total assets. Wu (2004) defines it as
the operating income before depreciation minus interest, tax and preferred shares dividends divided by the
book value of assets. Chu (2011) defines FCF as an operating income before depreciation minus income
tax expense, interest expense and expenses of investment. Wang (2010) defines FCF as the flows from
operating activities minus income tax, interest and dividend of preferred shares divided by the net sales. J
Khan et al. (2012) define FCF as an operating income before depreciation divided by total assets.
FCF can be used to pay debts (Griffin et al., 2010, Fleming et al. 2005), or to pay declared dividends
(Mollah et al., 2000, DeAngelo et al., 2004, and Amidu and Abor 2006 ), these dividends become payable
after the announcement date (Oded 2009). Sometimes managers do not tend to pay dividends whether is
a lot of free cash flow (Chen et al., 2011) because they tend to invest these flows in un productive projects
(Abor and Bokin 2010), or in unacceptable projects by the owners (Cardoso, et al., 2014,). But if these
flows are used to purchase shares of multinational companies, the control of foreign shareholders and
agencies make the control on FCF more effective, this will achieve control on the managers’ behavior and
ensure that their actions are acceptable by the owners (Coffee 2002, Cheng et al., 2014, Zhou et al., 2011).
This action will increase the possibility of the use of FCF in productive investment opportunities (Richardson
2006). The company can use FCF in purchasing its shares back (Kapavicius and Yu 2012), and therefore
the FCF analysis and the study of its impact on a lot of variables become important issues (Rezaei andJafar
2015), and if it easy to FCF predict, this will help in making investment decisions which are more optimistic.
The financial leverage represents the company’s use of debt to increase the return on equity as a
substitute of increasing the capital, (Friedlob, G.T. and Schleifor, L. F. 2003).
Company may distribute part of its profits to shareholders as dividends in cash or in the form of
shares, cash dividends, investors and shareholders usually interest with declaring dividend by the company.
Company should take in to account the availability of retained earnings and cash to pay the when it
decided to distribute dividends. But if the company take a decision to distribute dividends from the additional
capital, the dividends in this case is called liquidation dividend (Weygant et al., 2012.
There are many studies investigate the effect of FCF onfinancial leverage and dividends payout such
as the study ofTijjanii and Sani (2015) who examined the impact of FCF on dividend policy in the oil and
gas Nigerian companies depending on the annual reports of the samples that have been studied during the
period (2003- 2014), and they found that there is a positive impact of FCF on dividends policy .Rezaei s
and Jafari (2015) examined the relationship between financial leverage and the following variables: FCF,
investments, profitability, the percentage of Tobin’s Q, liquidity ratio, tangible assets and cash dividends,
depending on the financial data of 91 company listed in the Iranian capital market during the period (
2009- 2013), and they found that there is a statistically significant negative relationship between FCF and
the other variables.Sindhu (2014) examined the impact of FCF on dividend payout, depending on the
financial data of 30 Spinning company listed in Pakistan’s financial market during the period (2000 – 2009),
and he found that there is a non statistically significant effect of FCF on dividends payout. Chenge et al.,
(2014) examined the impact of FCF on the growth opportunities and dividend payout, depending on the
financial statements of 1105 Chinese companies during the period (2003-2011), and they found that the is
International Journal of Economic Research 4
Musa Abdel Latif Ibrahim Alnawaiseh, Rania Mohammad Alomari, Firas Al-Rawashdeh & Mahmoud barakat alnawaiseh
a positive statistically significant effect of FCF on dividends payout.Parsian and Koloukhi (2013) examined
the impact of FCF and profitability on dividend payout, depending on financial data of 102 Iranian’s
companies during the period (2005- 2010), and they found that there isa statistically significant effect of
FCF and profitability on dividends payout. Utamiand Inanga (2011) examined the relationship between
the Agency cost of FCF,dividends, and the financial leverage, depending on a sample of Indonesian
companies during the period (1994 – 2007), and they found that there is statistically significant effect of
FCF on dividends, and non- statistically significant effect on the financial leverage. Finally, Adelegan (2003)
examined the effect of FCF on the changes in dividends depending on the financial data of 63companies
listed in the Nigerian financial market during the period (1984 – 1997), and he found that there is a statistically
significant effect of FCF on dividends.
A review of the previous studies appears that there is a statistically significant effect of FCF on
dividends payout in the studies of Adelegan (2003), Parsian and Koloukhi(2013), Cheng et al., (2014),and
Utami and Inanga(2011), and non statistically significant effect of FCF on dividends payout in the studies
of Tijjani and Sani (2016), Sindhu (2014), and non-statistically significant effect of FCF on financial leverage
in the study of Utami and Inanga (2011).
THE STUDY METHODOLOGY
In the methodology researchers spoke about the study population, the study variables, how he measures
them, the statistical techniques, the hypotheses test, and the results discussion.
THE STUDY POPULATION
The study population consists of the 58 industrial companies listed in the AFM. The study depends on the
financial reports of these companies during the period (2005-2014).
THE STUDY VARIABLES
The study examines the effect of FCF (interdependent variable), on the financial leverage (dependant
variable) and the dividends payout (dependant variable) that measure the financial policies of the company.was
well controlled variable and control a company’s size.
Table 2
Variables, variables’ kinds, and Variables measurement
Variables Variable kind Measure Symbol
Free cash Flow dependant FCF ÷ Total Assts FCF
Financial Leverage interdependent Debts ÷ Total Assts LEV
Dividends payout interdependent Dividends ÷ The Company’s market value DIV
The Company’s Size Control variable Log assets SIZE
To measure the free cash flow the model of Brigham and Ehrhardt, (2008)was used, which is
represented by the following equation:
5International Journal of Economic Research
The effect of Free Cash Flow on the Companies’ Financial Polices: Evidence from Jordan
FCF i.t = EBIT i.t (1-T) + DE i.t - WC i.t - CAPEX i.t
Where FCF represents free cash flow for the company i in the period t.
EBIT represents income before interest and taxes for the company i in the period t.
DE represents depreciation, Depletion, Amortization expenses of the company i in thperiod t.
WC represents the change in the working capital of the company i in the period t and period t-1
CAPEX represents the Capital expenditures of the company i in the period t.
Financial leverage was measured by dividing total debts by the total assets, as in the studies of Hordar
and Tehrani (2015) and Khan et al., (2012). Dividend payout was measured by dividing dividends by the
company’s market value, as in the study of Utami and Inanga(2011). The company Size variable was
measured by using the logarithm of the company’s total assets.
STATISTICAL METHODS
In the study the averages and standard deviations were used to describe the variables characteristics, simple
regression analysis was used and to test the studies hypotheses, and Kolmogorov – Smirnovtechnique to
test the normal distribution of variables.
According to the descriptive statistics which was contained in Table No.3, the Standard deviations in
the variables data of all companies were low, the biggest figure was associated with a standard deviation of
the assets’and the least figure was associated with variable FCF.
Table 3
Variables’ descriptivestatistics
Variables N Minimum Maximum Mean Std. Deviation
FCF 58 -0.111 0.178 0.096 0.079
LEV 58 0.404 0.82 0.546 0.122
DIV 58 0.162 0.72 0.357 0.186
Size 58 9 10 9.7 0.483
To test the normal distribution of the study’s variables, Kolmogorov – Smirnov test was used, Table
4 appears that the relative importance of variables of FCF, LEV, and DIV was greater than 0.05, this
means that each of these variables had a normal distribution, while the companies’ Size variable didn’t
distributed normal.
Table 4
The normal distribution of the variables
Variables Kolmogorov - Smirnov Sig.
LEV 0.196 0.200*
DIV 0.179 0.200*
FCF 0.25 0.076
SIZE 0.433 0
International Journal of Economic Research 6
Musa Abdel Latif Ibrahim Alnawaiseh, Rania Mohammad Alomari, Firas Al-Rawashdeh & Mahmoud barakat alnawaiseh
Hypothesis testing and analysis of results
To test the study’s hypotheses, simple regression analysis was used to examine the relationships between
the different variables of the study
H02: There is no statistically significant effect of FCF on the financial leverage of the Jordanian
industrial companies which were listed on the ASE.
To test this hypothesis, simple regression between FCF and the financial leverage has been used in
accordance with the following model:
LEV it = 0 + 1 * FCF it + 2 * SIZE it + (1)
Where LEV represents the financial leverage of the company i in period t, and FCF represents free
cash flows of the company i in period t, and to avoid the disadvantages of depending on a single variable,
a company’s size has been entered in the model and measured by Log assets, represents the standard
error.
Table 5 appears the analysis of the relationship between FCF and LEV.
Table 5
The regression coefficients of the effect of FCF on Financial Leverage
Model Unstandardized Standardized t Sig. t R R2
Coefficients Coefficients
B Beta
1 (constant) 0.654 14.421
FCF -1.122 -0.729 -3.014 0.0000.017 0.729 a 0.532
Dependent Variable: LEV.
Table 5 appears that the value of R2 (0.532), this means that a 53.2% of the total deviations in
Leverage variable can be interpreted by the linear relationship in the model (1), and 46.8% was due to
random factors didn’t included in the model, and any increase in FCF by one unit, LEV willbe decreased by
0.468 units.
From table 5 we can conclude the model that appears the relationship between FCF and LEV (see
model no. 2)
LEV = 0.654 - 1.122 × FCF (2)
Table 5 also appears that there is a statistically significant negative effect of FCF on LEV, because the
value of p that accompanying with t statistics less than (0.05), so that the hypothesis H01 should be
rejected, this means that there is a statistically significant effect of FCF on LEV.
H02: There is no statistically significant effect of FCF on dividendpayout in the Jordanian industrial
companies listed on the ASE.
To test this hypothesis simple regression between FCF and dividend payout has been used in accordance
with the following model:
7International Journal of Economic Research
The effect of Free Cash Flow on the Companies’ Financial Polices: Evidence from Jordan
DIV I, t = 0 + 1 FCF i, t + 1 * SIZE i, t + 3
Where DIV represents dividends payout for the company i in period t, and to avoid the defects of depending
on a single variable, a company’s size is entered as a control variable and is measured by Log assets.
Table 6
The regression coefficients of the effect of FCF on Dividends payout
Model Unstandardized Standardized t Sig. t R R Square FChange Sig. F
Coefficients Coefficients
B Beta
1 (constant) 0.301 3.063 0.016 0.248 a 0.062 0.525 0.489
FCF 0.548 0.248 0.724 0.489
Dependent Variable: Div.
Table 6 appears that the value of R2 (0.062), this means 6.2% of the total deviations in dividends
payout values can be explained by the linear relationship between the two variables, and 93.8% were due to
random factors that didn’t included in the model(see model 4).
DIV = 0.301+ 0.584 × FCF (4)
Table 6 also appears that there is a positive and statistically significant effect of FCF and dividends
payout, because the value of p is greater than (0.05), so that the H01is accepted, and this means that there
is no statistically significant effect of FCF on dividend payout in the Jordanian industrial companies listed
in AFM.
CONCLUSIONS
It can be inferred, coming from a review of previous studies and the results of the current study:
1. The Financial Leverage is a financial instrument that helps in controlling the administration’s use
of FCF in preparing the dividend policy, borrowing policy and investment policy.
2. The effect of FCF on dividend payout depends on the level of growth, capital structure, and the
size of the company, changes in economic policies (Adelegan, 2003).
3. The Results of the study shows that there is a statistically significant effect of FCF on the
financial leverage in the Jordanian industrial companies. This result is consistent with the results
of Razaei and Jafari (2013) study, and doesn’t consistent with the studies of Utami and Inanga
(2011), and Mustafa and Chae (2012).
4. the study shows that there is un statistically significant effect of FCF on dividends payout, this
result is consistent with the results of the studies of Lincing, (2005), Tijjani and Sani (2016), and
Sindhu (2014), and doesn’t consistent with the results of the studies of Adelegan (2003), Parsian
and Koloukhi (2013), Cheng et al., (2014), and Utami and Inanga (2011).
5. The result of this study regarding the impact of FCF on dividends payout may not agree with
the logic which says that if the company achieves an increase in FCF with profits, it should
International Journal of Economic Research 8
Musa Abdel Latif Ibrahim Alnawaiseh, Rania Mohammad Alomari, Firas Al-Rawashdeh & Mahmoud barakat alnawaiseh
announce dividend. This will increase investors’ demand on its shares, and will increase its share
price, and will increase the Owner’s wealth, however, only 15 % from the Jordanian industrial
companies did that, because agency problems.
RECOMMENDATIONS
In light of the previous findings, the study recommends the following:
1. Companies should focus on disclosure in accordance with the requirements of IAS 1.
2. The interested bodies of accounting should choose a particular definition of FCF to help users
in calculating this important index, which results in decisions of building the leverage and dividend
policy.
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