Free cash flow, investment inefficiency, and earnings management: evidence from manufacturing firms listed on the Indonesia Stock Exchange

Abstract

The study aims to test investment inefficiency of fixed assets in mediating the relationship between free cash flow and earnings management and to test the controlling shareholders in moderating the relationship between free cash flow and fixed assets investment inefficiency. The research problem proposed in this study is whether the use of free cash flow for the investment inefficiency of fixed assets is able to ultimately improve the managerial performance. This research investigates new empirical evidence related to management earnings practices caused by free cash flow fixed assets investment inefficiency. The study was conducted on all the manufacturing firms listed on the Indonesia stock exchange from 2010 to 2015. The data used are secondary data in the form of the firms' financial statements. Using purposive sampling, 314 units were analyzed from 69 manufacturing firms. The estimation of the path model was completed using Structural Equation Modeling (SEM) by WarpPLS program version 5.0. The results showed that free cash flow is positively related to earnings management. Fixed assets investment inefficiency is able to mediate the relationship between free cash flow and earnings management.

ESG and Firm Performance: Focusing on the Environmental Strategy

“…As a motivator within the organization, sales growth enables the promotion and retention of excellent employees and upgrades the production process by enabling investment in new equipment and technologies. If a company's sales are good, the company can raise more money, which is needed for continuous growth or to enable investment in other areas, than a company with poor sales [31]. The growth in sales allows the firm to utilize its capacity to a higher level than before, which serves to further spread the fixed costs over profits; thus earning higher profits.…”

Free Cash Flow and Investment Efficiency of Listed Manufacturing Companies in Nigeria

“…Firms invest efficiently in a perfect market when they undertake all the investments that will result in positive net present value projects and discard those investments that will lead to harmful net present value projects. Though previous studies (e.g., Angela & Rilya, 2017;Chen, Hope, Li, & Wang, 2011;Cherkasova & Rasadi, 2017;Fakhroni et al, 2018;Guariglia & Yang, 2016;Nekhili, Fakhfakh, Amar, Chtioui, & Lakhal, 2016) suggest otherwise, this is as a result of the presence of market frictions. Thus, market frictions resulting in a clash of interest between shareholders, managers, and other stakeholders leads to agency conflict and asymmetric information.…”

“…The agency cost explanation is more so for companies with excess FCF. The agency cost problem of FCF is a problem between management and shareholders of the firm related to the company's usage of its excess FCF (Fakhroni et al 2018). The clash of interests between the management and the outsider could lead managers to expropriation by utilizing the firm's FCF (Jensen, 1986).…”

Does feedback effect exist in firms' investment decisions? From the perspective of equity liquidity

“…Although the relationship between information asymmetry and firms' financial decisions is not a new topic, the interactive mechanism between information asymmetry and firms' investment decisions has received little attention. When managers possess more private information than the capital market does, they are prone to engage in self‐interested behavior (Fakhroni et al, 2018; Hope & Thomas, 2008; Jadiyappa et al, 2020; Liu et al, 2012; Rashid, 2016), which is exactly what the agency theory describes.…”