The Agency Costs of Free Cash Flow

Agency costs of free cash flow refer to the potential problems that arise when company managers have more money than they need. With extra cash, managers might make decisions that benefit themselves—like pursuing unnecessary projects or perks—instead of maximizing shareholder value. These behaviors can lead to higher costs for shareholders, such as reduced profits or lower stock prices. Essentially, free cash flow creates opportunities for management to pursue personal interests, and addressing these conflicts involves monitoring and incentives that align managerial actions with shareholders’ best interests.