How institutional monitoring creates value

evidence for the free cash flow hypothesis

Sigitas Karpavičius*, Fan Yu

*Corresponding author for this work

Research output: Contribution to journalArticle

4 Citations (Scopus)


Institutional ownership of U.S. equities increased from 9.4% in 1980 to 42.9% in 2009. This paper analyzes the indirect role of institutional investors in monitoring firm managers and in the process of shareholder wealth maximization. Institutional monitoring reduces the agency problem of free cash flow. Controlling for reverse causality, we find that increased institutional ownership results in lower leverage and dividend payout that consequently lead to greater cash holdings and firm value. The results are consistent with the free cash flow hypothesis and provide an alternative explanation for why firms hold so much cash and why debt and dividends have decreased during the last thirty years.
Original languageEnglish
Pages (from-to)127-146
Number of pages20
JournalInternational Review of Economics and Finance
Publication statusPublished - 1 Nov 2017


  • Agency problem
  • Free cash flow hypothesis
  • Institutional ownership
  • Cash holdings
  • Capital structure
  • Dividends

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