Abstract

The study concentrates on audit committee characteristics and their influences on free cash flow. A panel of 120 firms from the trading and services industry from the year 2005 to 2008 is examined. The results show a significant and positive relationship between Audit Committee characteristics (size, independence, frequency of meetings) and free cash flows. These findings suggest that effective audit committee governance leads to availability of higher free cash flows. Our study draws upon the lack of understanding on the impact of audit committee characteristics on free cash flow along the two views; agency theory and pecking order/transaction cost theory and finds support for the later.

Introduction

The issue of agency problem is very relevant particularly to the use of surplus free cash flows by managers, especially in Malaysia where the legal protection of minority shareholders is relatively weak compared to some developed countries (La Porta, Lopez-de-Silanes, Shleifer&Vishny, 1998). The Malaysian corporate governance scene is overshadowed by a number of weak corporate governance elements . While the topic of free cash flow has gained considerable attention in relation to firms’ stock returns (see Livnat and Zarowin, 1990; Ali, 1994; andKallunki et al., 1998), debt structure and investment (see Harvey, Lins, and Roper , 2004) and executive compensation (see Garvey, 1997; Broussard, Buchenroth, and Pilotte, 2004) little attention has been paidin relation to audit committee on the former. It would amount to an overstatement to state free cash has not been examined in corporate governance studies and in particular audit committee. But ironically most of these studies examine free cash flow as one of the many antecedents8 together with 7The common features of weak corporate governance in Malaysia are, large corporations are usually family-owned (Thilainathan, 1999; Cutler, 1994; Lang et al, 1999), large percentage of insider holding, weak minority shareholders rights (Reed, 2002; Thilainathan, 1999), financial scandals and government bailouts (Gomez and Jomo, 1999). 8 See e.g. Basiddiq, H. and Hussainey, K. (2011); John and Knyazeva, (2006); Al-Najjar and Hussainey (2009) corporate governance in relation to topic or outcome of their studies. Little attention has been paid to the antecedents of free cash flow itself whilst it is established in the literature that aneffective and efficient audit committee do resolve agency conflicts(Klein, 2002) of which the free cash flow issue remains a central contention.