A test of the free cash flow hypothesis

Abstract

We develop a measure of free cash flow using Tobin's q to distinguish between firms that have good investment opportunities and those that do not. In a sample of successful tender offers, bidder returns are significantly negatively related to cash flow for low q bidders but not for high q bidders; further, the relation between cash flow and bidder returns differs significantly for low q and high q bidders. This result holds for several cash flow measures suggested in the literature and also in multivariate regressions controlling for bidder and contest-specific characteristics.