Impact of Free Cash Flows

Impact of Free Cash Flows, Equity Concentration and Agency Cost on Performance of Manufacturing Firms: A Case Study on Cement Sector of Pakistan

Introduction of Research ScholarIntroduction of Supervisor
Name:Rana Tauqeer AliName:Tahir Mehmood
Roll No.: 03Designation:Lecturer
Class: M. Phil Commerce Department:Commerce & Accountancy
Session: 2017-2019Institution: Govt. College Township Lhr.

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School of Commerce & Accountancy
Faculty of Economics and management Sciences
MINHAJ UNIVERSITY LAHORE
Hamdard Chowk Township Lahore
Research Proposal Form
Program: M. Phil Session: 2017 – 2019
Subject: Commerce
Name of Student: Rana Tauqeer Ali Roll No: 03
Father’s Name: Rana Asghar Ali
Impact of Free Cash Flows, Equity Concentration and Agency Cost on Performance of Manufacturing Firms: A Case Study on Cement Sector of Pakistan
Introduction
The free cash flows theories were introduced in 1986 for the first time by Jensen and it gradually evolved, as one of the new topics in the financial literature which describes the behavior of companies that is not justifiable with previous economic theories and describe that free cash flow is the sum of the surplus funds available after profitable investments. The positive relation between abundance of cash flows and lack of good growth opportunities is often referred. Subsequently, the existence of a substantial level of free cash flow might lead managers to choose for viable investment policies. To conceal their projects counter-performance, managers may engage in aggressive earnings management practices. Free cash flow is the volume of cash that an entity retains after paying off money for all the capital type and current type of expenses of the firm.01
The idea of free cash stream can have more than one explanation proposed following two explanations for free cash flows (1) the conventional definition is that the funds paid for company’s investment are deducted from operating cash flow. (2) A newer formula for Free Cash Flow calculation equals to the addition of discretionary cash outlays (DCO) and discretionary capital expenditure (DCAPEX) to the traditional free cash flows. 02
Companies that have high free cash flow are likely to attract investors that look for efficient opportunities to invest their additional resources in the market. Creditors and investors are willing to invest in companies that have high free cash flows because the strength of debt kickback and the definition of financial flexibility of the company are the means for assessing these companies. In addition, cash profits and debts reduction are not possible without possession of cash paying. Free cash flows is one of the key tools for measuring the financial performance of business unit and shows the cash that company has after performing the necessary costs for maintenance or development of assets.Free cash flows can have important applications for shareholders in assessing the financial soundness of the business unit. The managers who invest free cash flows in projects with positive net present value (NPV) as a result of efficient use from their owned resources contribute to the increase of the firm value. Firms have a choice between internal and external sources to finance their investments. Internal sources include retained earnings and depreciation, while external sources refer to debt and equity 4.

Objectives of the StudyThe main objectives of the study are as follows.

To determine the impact of free cash flows and Equity Concentration on firms performance.

To determine the impact of equity concentration on firms performance.

To determine the impact of agency costs on firms performance.

Significance of the Study
The main objective of this research is to examine that how free cash flow and equity concentrations with association of agency costs influence the performance of Cement Firms in Pakistan. Little attention has been given in Pakistan on Free cash flow and equity concentrations with association of agency costs to determine the effects on firm’s performance of Cement Sector. The findings of this study will benefit the academicians and researchers intending to use findings of this study as a basis for further research. The study will also be useful since it will add more knowledge on the effect of free cash flow on profitability by firms listed at the Pakistan Stock Exchange.
The findings of this study will also provide more insights to foreign and local investors on the effect of free cash flow on investment while considering investment decisions and diversification of portfolios to increase profitability. Financial analysts and consultants stand to benefit from the findings of this study; it will enable them provide improved financial services especially on investment decisions in order to achieve an increase profitability.

Research Hypothesis
First Hypothesis
H0: Free Cash Flows has no impact on firms performance.

H1: Free Cash Flows have a positive impact on firms performance.

Second Hypothesis
H0: Equity Concentration have no impact on firms performance.

H1: Equity Concentration have an impact on firms performance.

Third Hypothesis
H0: Agency Cost may have no impact on firms performance.

H1: Agency Cost have an impact on firms performance.

Literature review:
Free cash flow (FCF) can also be defined as cash available for resource provider (equity or debt provider) defines free cash flow as cash in excess of that which is required to fund all positive net present value projects. Free cash flow is a firm’s net income plus depreciation/amortization and all other non-cash charges minus changes in working capital and expenditure. Free cash flow is the amount of cash left after paying the bills and making new investment and on – going capital improvements. 04
Maintaining suitable amount of liquidity within the firms is fundamental for the smooth operations of firms. Managers have a propensity to hold large percentage of firm assets in the form of cash and cash equivalents in order to reinvest on other physical assets, payments to stockholders and to keep cash inside the firm11
Notes that profitability of a firm means the ability to make profit from all the business activities of a firm or an enterprise. It shows how efficiently the management can make profit by using all the resources available in the market. 05
Recent research by shows that relationship between free cash flows and profitability is positive as well as significant, a surge in the level of cash flow of a firm leads to a corresponding increase in profits of the firm. This is achieved through investing. The firm should consider making key investment decisions to make use of additional cash flows. For example, the firms that hold excess cash might use it in buying overpriced firms rather than paying out dividends to the shareholders. This is possible even when the firms have a low financial capacity after making acquisitions since they invest in non-profitable investment projects. 09
Free cash flow is cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital. Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial free cash flow. The problem is how to moti- vate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies 3.

Margin Ratios are used in measuring the profitability of a firm for instance gross profit margin which looks at the costs of goods sold as a percentage of sales. The other measure is operating profit margin also known as EBIT which measures the overall efficiency of the manufacturing firm 12.

Ratios that show margins represent the ability of the firm to translate sales into profits at various stages of measurement. Ratios are essential tools for measuring profitability of firms because they illustrate the ability of the firm to measure its overall efficiency in generating returns to its shareholders 14.

Recent research by shows that there is a significant positive relationship between free cash flows and profitability, an increase in the level of cash flow of a firm leads to a corresponding increase in profits of the firm. This is achieved through investing. The firm should consider making key investment decisions to make use of additional cash flows. For example firms that hold excess cash might use it in buying overpriced firms rather than paying out dividends to the shareholders. This is possible even when the firms have a low financial capacity after making acquisitions since they invest in non-profitable investment projects 11.

Secondly, the pecking order assumes that managers act in the best interest of their existing shareholders, maximizing the value of existing shares, so that, they will even forego positive NPV projects if accepting them forces the firm to issue undervalued equity at higher issuing costs to new investors which would in part disadvantage their existing shareholders 15.

Conducted a study on the relationship between the determinants of working capital management i.e. inventory, debtors, creditors, and the cash level of Kenyan SMEs. This research was conducted through a survey study. The target population of this study was the sampled 205 SMEs. Data was analyzed using a regression model and the results of the study found that firms with greater cash flow volatility hold more cash in order to provide a safe cushion for smooth operations. 22
In another study carried out in London, did a cross sectional survey of UK takeovers of listed domestic companies using 8 years trend, 67 firms were selected and trend analysis was conducted to establish the pattern of performance of listed takeovers and free cash flow, the results of the study revealed that there was an inverse relationship between performance of UK takeovers of listed domestic firms and free cash flow. 12
Conducted a study on earnings and free cash flow to evaluate corporate performance among commercial banks (43) in Kenya, a descriptive survey 19 was conducted and data was analyzed using descriptive statistics, the results of the study revealed that there is no significant difference between free cash flow measure of corporate performance and that of earnings especially when the amount of maintenance capital spending cannot be properly segregated.17
Analyzed the impact of cash flow on profitability among commercial banks in Kenya over a period of five years from 2005- 2009. The objective of the study was to establish the causality that exists between the profitability and cash flow. The findings for the study indicated that profits among commercial banks improved tremendously during the last five years. Cash flow from operating activities experienced the same trend which was occasioned by the improved performance which translated to financing and investing cash flow which have shown consistent increase over the five years. 13
According to the theory of modern Portfolio (MPT) takes into consideration the whole market and the entire economy of a country in order to explain the investing activities. This philosophy is actually seen as a substitute to the earlier approach used to make an analysis of each investment’s individual merits. Investors explore individual merits of each investment; they are more inclined to analyze one venture without taking into consideration how well or bad the other portfolio will perform in relation to one another. Contrary to that, MPT largely emphasizes the way investments are correlated to each other. 6
According to multinationals with more opportunities for growth ; expansion and with an escalating free cash flow will have a higher value price, and additionally free cash flow is positively related to stock return while profitability is short-term. 4
Research Problem
The actual problem is in the very fact that how managers can be inspired to disperse the free cash flow instead of making an investment of free cash flow at an interest rate less than cost of financing their business or losing it on business in ineptitudes. This study strive to solve the research problem by trying to investigate the relationship between firm’s performance and its free cash flow. It also attempts to explore the probable influence of free cash flow on the performance of the firms.

Research Gap
A lot of work have been done on free cash flow effect on profitability internationally but in Pakistan a very little work have been done on free cash flow and no study have been seen in Pakistan on equity concentration with Free Cash Flow and Agency Cost altogether in Cement Sector. This study focus as the, specially, the cement Industry in which most of the firms are facing loses or having low return on assets as compare to other sectors. In current scenario due to CPEC the consumption of Cement is increased and this study fill the gap while suggesting valuable suggestions to maximize the shareholder wealth efficiently utilizing the free cash flows.
Research Questions
The following are the research questions of this study.

What is the impact of free cash flows and Equity Concentration on firms performance?
What is the impact of Equity Concentration on firms performance?
What is the impact of agency costs on firms performance?
MethodologyThis section includes research paradigm, research approach and research design. Research framework (research approach, research strategy, population, data collection, sampling technique and data analysis techniques which are used to analysis the data).

3.2 Research DesignIn this research descriptive design used to analyze the effect of free cash flow on the profitability of firms listed at the Pakistan Stock Exchange. Research ApproachThere are two types of research approaches used in social sciences i.e. inductive approach and deductive approach. In inductive approach we have very little knowledge about the situation so we started with the phenomena and then generate the theories in other words in induction we starts with general and ends with specific theory.
In deductive approach, we have many theories in literature review, we use these theories and models as a base for study and then make hypothesis from these theories and then test these hypotheses from different statically tools and techniques and finally make the conclusion from results. So in this study we will use deductive approach.

Research StrategyThere are two types of research studies in business research i.e. qualitative and quantitative. The qualitative strategy is focused on non-numeric values. In other word, it includes words rather than the numeric values. In qualitative strategy we focused on word rather than the results and in this strategy results cannot be generalized due to the limited sampling size or data collection methods.
While in quantitative strategy we focused on results which are derived from the data which is collected from large sample and these results can be generalized. So in our research we used quantitative research strategy which is most suitable strategy for our study.
Population
Describe target population as the complete set of individual’s cases or objects that are being investigated. The population of this study is the companies listed in Pakistan Stock Exchange.

Sample Selection
A stratified sampling technique was used to select a study sample of 30 companies listed at KSE. This was used because the population (listed companies at PSE) is heterogeneous but certain similar or homogeneous subpopulations (company sectors) can be isolated. A sample size of 30 is usually considered statistically significant. This study was conducted for a period of ten year (2008 –2017) of companies in cement sector.
Sampling Frame
Sampling frame means the list of the elements in the population. It is not necessary that in all type of research sampling frame is available or if available it may be outdated or incorrect. In our this study sampling frame is the cement companies listed in Pakistan Stock Exchange having data of 10 years.
Data Collection
We shall collect data from the Pakistan Stock Exchange, annual report of individual companies and balance sheet analysis of State Bank of Pakistan.

Analytical Model
To achieve the objective of this study, the researcher used a multiple regression model to establish the relationship between free cash flow and the profitability as shown below:
PY = a + b1x1 + b2x2+ b3x3+ b4x4+e
Y= Performance of firms which may be measure in ROA/ROE /NP
X1 = Free cash flows was determined using operating cash flow minus capital expenditures.

X2= Equity Concentration of Firms
X3= Agency Cost
X4=Natural log of Total Assets
b= Slope of the regression measuring the amount of the change in Y associated with a unit change in X
e =Error term within a confidence interval of 5%
Data Analysis
5.1. Descriptive Analysis
This part shows the summary statistic of overall data. Which includes such as the mean value, standard deviation, maximum and minimum values of all variables.
Quantitative Analysis
In quantitative Data analysis first part includes Pearson correlation matrix which measured degree of association between the different variable used in this research. Secondly GLS method is used to estimate the results of penal data. Stata software will be used to analyze the financial data.

Research Findings and Discussions
This is major part of a research study which consists on research findings and comprehensive discussions upon those finding and check the consistency with previous research studies. The component should be evaluated separately at different level of significance.

Limitation of study:
The limitation of this study is that it utilized secondary data, which might be historical. The researcher exercised a lot of caution when using dated information from the previous years.
The information may be collected through questionnaire or through primary sources. This study will be limited to Cement Sector only it will be expanded to other sectors.

Conclusions
Conclusion is the final part of research studies it summarize and concludes the overall research study and highlight its limitation and suggestions for further studies in the areas.

Proposed Chapters for thesis
Chapter No. 1
Introduction
In this chapter, we will discuss about the free cash flows, equity concentration and other variable used in this research and also discuss about the Introductions of our research questions.
Chapter No. 2
Literature Review:
This chapter will provide the secondary source research conducted and another researcher point view about the already research published on firms free cash flows, equity concentration and the related topics.

Chapter No. 3
Research Design and Analysis:
This chapter will explain the complete Research Design, Hypothesis, Research objectives, Research questions and Research methodology to be used in secondary source research to be undertaken for the research thesis. The chapter will also include the data analysis.
Chapter No. 4
Findings, Recommendations and Conclusion:
This chapter will discuss the key findings from pure primary source research and draw meaningful conclusions and make appropriate recommendations on our research topic for further research.

This will show a conclusion of the research work based on the analysis and findings of the research.

Chapter No. 5References or Bibliography

ReferencesBruner, Robert F. (1995). The Use of Excess Cash and Debt Capacity as Motive for Merger. Colgate Darden Graduate School of Business.
Chang, S. C., Chen,C. C., Hsing, A. ; Huang, C. W. (2007). Investment Opportunities, Free Cash Flow, and Stock Valuation Effects of Secured Debt Offerings, Review of Quantitative Finance and Accounting, 28(4) 123-145.
Griffith, J. M. ; Carroll. C. (2001). Free Cash Flow, Leverage and Investment Opportunities. Journal of Business and Economics, 1(2):1-5
Habib, A. (2011). Growth Opportunities, Earnings Permanence and the Valuation of Free Cash Flow. Australasian Accounting Business and Finance Journal, 5(4), 101-122.
Hann, N., Ogneva M, ; Ozbas O. (2010).Corporate diversification and the cost capital. 2010, SSRN Working Paper,(2):1-5
Harford, J. (1999). Corporate cash reserves and acquisitions. Journal of Finance, 54, 1969–1997.
Hovakimian, A. H. (2009). Cash Flow Sensitivity of Investment. European Financial Management, 1(2):5-1 40
Howe, K. M., He J. ; Kao, G.W. (1992). One-time cash flow announcements and free cash flow theory: Share repurchases and special dividends. Journal of Finance 17, 1963-1975.
Hubbard, R. G. (1998). Capital-market imperfections and investment. Journal of Economic Literature, 36, 193225.
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance and takeovers. American Economic Review 76, 323-329
Lang, P., Stulz, M. ; Walkling, A. (1991). A test of the free cash flow hypothesis: The case of bidder returns. Journal of Financial Economics, 29, 315–335 41
Markowitz, H.M. (1952). Portfolio Selection, Journal of Finance, 12:1,1-4
Modigliani, F. ; Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48, 261–297.
Mohammad Ebrahimi, G. N. (2011). The Effect of Free Cash Flows, Growth Opportunities and Dividend to market value of share ratio, International Conference on Humanities, Society and Culture.
Mohan, R. (2006). Causal relationship between savings and economic growth in Countries with different income levels, Economics Bulletin, 5(3):1?12
Mong’o, G. (2010). The relationship between cash-flows and profitability of commercial banks in Kenya, Unpublished MBA Project, University of Nairobi
Mugenda, O. M & Mugenda, A. G. (2003). Research Methods, Qualitative & Qualitative approaches.
Van Horne, J. C. (2000). Financial Management and Policy, Englewood chiffs.
Wang, G. Y. (2010). The Impacts of Free Cash Flows and Agency Costs on Firm Performance. J. Service Science & Management, 1(2):1-5
ZHOU Hong, Y. S. (2012). Relationship between Free Cash Flow and Financial Performance and evidence from the listed real estate companies from china. International Proceedings of Computer Science and Information Technology, 1(2):1-5
Report of the Supervisor
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Name & Signature of the Supervisor
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Time Table/Work Plan
Semester 3 (16 weeks)
Week Work / Activity Comments by Supervisor
03 Weeks Allotment of Research Topic & Supervisor Do
01 Week Finalization of Research Topic Do
04 Weeks Literature Review and Methodology Do
06 Weeks Sample Collection and Preparation for Analysis Do
01 Week 1st Seminar Do
Semester 4 (16 weeks)
Week Work / Activity Comments by Supervisor
08 Weeks Sample Analysis and Interpretation Do
01 Weeks 2nd Seminar Do
02 Weeks First Draft Do
01 Weeks Second Draft Do
02 Weeks Final Draft Do
02 Weeks Submission of Thesis Do
Name & Signature of the Candidate
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