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Received 9 May 1997
Final revision received 18 July 1999
Key words: sales growth, agency, free cash flow, governance
business is business!
And business must grow
-Dr. Seuss, The Lorax
The paper investigates the agency argument that sales growth in firms with free cash flow (and without strong governance) is less profitable than sales growth for firms without free cash flow. It also tests whether strong governance conditions improve the performance of firms with free cash flow and/or limit the investments in unprofitable sales growth. Consistent with agency theory, firms with free cash flow gain less from sales growth than firms without free cash flow. But different governance conditions affect sales growth and performance in different ways. Having substantial management stock ownership mitigates the influence of free cash flow on performance, despite allowing higher sales growth. In contrast, outside blocks held by mutual funds reduce sales growth substantially, but does not increase performance from sales growth. Copyright (C) 2000 John Wiley & Sons, Ltd.
INTRODUCTION
Most firms value sales growth. The business press and corporate annual reports frequently include statements like: "We plan to double sales in the next five years," or "Our objective is to be a $2 billion company within 7 years." The popular business press contains many examples of companies that focus on sales growth as a key to profitability. For example, Emerson Electric is well known for its string of 40 consecutive years of increased earnings. When asked for the secret, the CEO Chuck Knight replied, "You can't just cut, cut, cut, cut. . . You simply must have sales growth to get sustainable performance at the bottom line" (Fortune, 1998).
Academics, on the other hand, have argued that growth sometimes benefits managers rather than stockholders. The "managerial capitalism" tradition in economics investigates what happens when managers, as opposed to owners, run large corporations (Berle and Means, 1932; Marris, 1964; Baumol, 1967; Marris and Wood, 1971). Researchers in this tradition argue that managers sometimes make decisions in their own interest rather than the interest of the company's owners. Indeed, more than 200 years ago, Adam Smith (1776) pointed out that hired managers do not take as much care of their firms as do owners. Agency theory extends this...