Abstract

This study directly relates corporate governance to agency costs of free cash flow in acquisitions. We proxy for agency costs of free cash flow by two measures: free cash flows at the fiscal year-end prior to the acquisition announcement and the eventual use of internally generated funds to finance the transaction. We investigate four aspects of corporate governance: institutional investor monitoring, board monitoring, the presence of antitakeover provisions, and executive incentive strength. We find that the quality of corporate governance indirectly affects merger outcomes by mitigating the agency problem associated with the holding, rather than the use, of free cash flows.