INVESTIGATING FREE CASH FLOW, AGENCY PROBLEMS, AND OVERINVESTMENT: A COMPARATIVE ANALYSIS OF SMALL-CAP AND LARGE-CAP FIRMS

Abstract

The paper has examined the relationship between free cash flow, agency problems and overinvestment by the small-cap and large-cap company between the period of 2015 and 2025 in Pakistan Stock Exchange. The method used by the researcher was a quantitative approach to the research and secondary data consisting of 150 small-cap and large-cap companies. The ways of determining the free cash flow include operating cash flow minus capital expenditure and overinvestment is established by residuals of anticipated investments. Proxies of agency costs were the asset utilization ratio, operating expense ratio and discretionary accruals. It was done through panel data regression analysis basing on fixed and random effects models to test the hypothesized relationships. The findings have revealed that the effect of free cash flow on overinvestment in the two kinds of firms was positive, but the association was stronger in the small cap firms. This relationship was also moderated by agency issues to a considerable extent which indicated that the greater the agency cost, the greater the tendency to overinvest where the level of free cash flow was large. The comparative analysis revealed that there was more efficiency in investments and less agency costs among large-cap firms as compared to small-cap firms. These are important findings to the corporate governance practice, investment policies and regulatory measures in the capital market within Pakistan.