An investigation into the effect of
surplus free cash flow, corporate
governance and firm size on
earnings predictability
Redhwan Ahmed AL-Dhamari and Ku Nor Izah Ku Ismail
School of Accountancy, UUM College of Business, Universiti Utara Malaysia,
Sintok, Malaysia
Abstract
Purpose – Existing studies on corporate governance mainly focus on how a strong governance
system enhances the valuation of firms with cash holding or free cash flow agency problem. The aims
of this paper are threefold. First, it investigates the impact of surplus free cash flows (SFCF) on
earnings predictability. Second, it investigates whether corporate governance variables moderate the
negative impact of SFCF on earnings predictability. Finally, this study examines whether the ability of
corporate governance to mitigate SFCF and improve the predictive value of earnings varies between
large and small firms.
Design/methodology/approach – This paper uses heteroskedasticity-corrected least square
regressions upon a sample of Malaysian listed firms.
Findings – This paper finds that firms with high SFCF experience less earnings predictability. It also
indicates that earnings of firms with high SFCF are more predictable when institutional investors
hold a large stake of shares and when a chairperson is independent. Finally, this paper reveals that the
role of institutional and managerial ownership in mitigating agency conflict of free cash flow and
improving earnings predictability is more prominent in larger firms. This study implies that investors
still have reservations about the ability of boards to enhance earnings numbers in Malaysia, although
efforts were taken to reform the corporate governance mechanisms following the Asian financial crisis