Agency Costs, Free Cash Flow and It Expenditures

1.0 INTRODUCTION In the past few decades, U.S. businesses have made large investments in information technology (IT), without decisive evidence about the value of such investments [1]. A natural question that arises in this context is whether managers have wasted organizational resources through large investments in IT. In his well-known free cash flow hypothesis, Michael Jensen argues that managers in firms with large free cash flows have an incentive to waste organizational resources on negative NPV projects, rather than pay out the excess cash to shareholders through dividends or share repurchase schemes [2]. Jensen argues that the impact of free cash flow on organizational inefficiencies is most pronounced in low growth firms because such firms have few positive NPV investment opportunities. The free cash flow hypothesis has generated tremendous interest in the finance literature and has been empirically verified in a variety of contexts ([3], [4]). The relationship between a firm's free cash flow, its growth and investment opportunities, and its level of IT spending has not been investigated in the IS literature. However, such an analysis can provide two important insights : (a) Difference in IT spending between high growth and low growth firms : Is the high level of IT spending a consequence of the agency problems associated with free cash flow? Do firms with low growth opportunities and large free cash flows spend more of