Firm Value, Free Cash Flows and Financing Decision: Evidence from Japan

Using Japanese firm data, this paper examines the relationship between firm value and financing decision factors within a free cash flow (FCF) framework. The findings are broadly consistent with the positive tax benefits hypothesis. We find that in firms leverage is positively related to firm value and dividends are negatively related to firm value during the sample period, 1985 to 1996. The result is contrary to the recent study on US firms conducted by Fama and French (1998). We also find that net investment outflows (NIF) are found to capture information on expected profits not captured by net operating cash flows (NOF). No significant differences in the relationship between the growth rate of firm value and leverage and dividends are found over the “bubble” economy periods in the 1980s or over the adjustment periods in the 1990s. JEL classification: G320