The Free Cash Flow Theory and Its Implications for Dividend Policy Decisions

Abstract

Free cash flow plays a crucial role in corporate financial decision-making, particularly in dividend policy. Its significance lies in its direct impact on liquidity, investment opportunities, and overall corporate performance. This study aims to examine the impact of free cash flow on corporate dividend policy and analyze how it influences management decisions regarding dividend payments to shareholders. This study employed a narrative review method, drawing from previous scholarly articles and research related to free cash flow and dividend policy. Data were collected from credible academic sources and analyzed descriptively. The findings revealed that companies with high free cash flow tend to distribute more dividends to shareholders due to having sufficient liquidity for both internal investments and dividend payments. Additionally, in companies with limited investment opportunities, excess free cash flow is more likely directed towards dividends. On the other hand, companies with lower free cash flow prefer to retain cash for potential investments. Dividend policy also acts as a mechanism to control managerial behavior and reduce agency problems. Free cash flow has a significant influence on dividend policy. Financial managers should consider liquidity status, investment opportunities, and strategic goals when making decisions about dividend payments. Furthermore, paying dividends can enhance investor trust and increase a company's stock value.