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Does Debt Structure Explain the Relationship between Agency Cost of Free Cash Flow and Dividend Payment? Evidence from Saudi Arabia

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  • Moez Dabboussi

    (Department of Finance and Investment, College of Business, Jouf University, Sakaka 72388, Saudi Arabia)

Abstract

This paper investigates the impact of debt financing on dividend payments when they face the agency costs of free cash flow. It focuses on a sample of 120 firms listed on the Saudi Stock Exchange during the period of 2011–2021. The findings from the Generalized Least Squares regression model revealed that the presence of agency costs of free cash flows may limit the funds available for dividend payments. Regarding the moderating effect of debt structure, the research highlights the significant role of long-term debt in making more prudent use of free cash flow. The use of long-term debt becomes more effective and can enhance shareholder wealth when a firm is facing agency costs of free cash flow. More specifically, bondholders primarily focus on affirmative covenants which require the firm to undertake specified actions such as maintaining assets and financial ratios, or paying taxes, but they do not restrict financing activities such as dividend payments. Since interest and debt repayments are fixed obligations, using free cash flow for dividend disbursement is considered a more profitable and beneficial approach for shareholders in the context of Saudi Arabia. This study contributes to our understanding of financial management under different debt structures and improves our scientific knowledge of the culture of Saudi firms regarding the dividend distribution policy.

Suggested Citation

  • Moez Dabboussi, 2024. "Does Debt Structure Explain the Relationship between Agency Cost of Free Cash Flow and Dividend Payment? Evidence from Saudi Arabia," JRFM, MDPI, vol. 17(6), pages 1-13, May.
    • Handle: RePEc:gam:jjrfmx:v:17:y:2024:i:6:p:223-:d:1402204
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    References listed on IDEAS

    as
    1. Anis Ali & Abdul Rahman Shaik, 2022. "Effect of Debt Financing on Firm Performance: A Study on Energy Sector of Saudi Arabia," International Journal of Energy Economics and Policy, Econjournals, vol. 12(6), pages 10-15, November.
    2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    3. Kwon, Sewon & Ahn, Jae Hwan & Kim, Gi H., 2021. "The impact of shareholder intervention on overinvestment of free cash flow by overconfident CEOs," International Review of Financial Analysis, Elsevier, vol. 75(C).
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