According to Jensen’s free cash flow hypothesis, a company’s shareholders could decrease agency costs by demanding that management pay out all free cash flow as dividends. Such a solution would most likely appear in which type of company? A. Large-cap value stock. B. Large-cap growth stock. C. Small-cap growth stock.

The correct answer is Option A. In general, it makes sense for small or growing companies in industries characterized by a rapid change to hold cash and pay low or no dividends but it does not make sense for large, mature companies in relatively non-cyclical industries. Growth stocks need to reinvest in growth, whereas value stocks tend to generate strong free cash flow and have significantly fewer investment options.

A CFA Level 2 Discussion About Question Of The Week: Level 2

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- MarkMeldrum
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  17 Apr 2020 at 7:10 am
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  According to Jensen’s free cash flow hypothesis, a company’s shareholders could decrease agency costs by demanding that management pay out all free cash flow as dividends. Such a solution would most likely appear in which type of company?
  - A. Large-cap value stock.
  - B. Large-cap growth stock.
  - C. Small-cap growth stock.
- MarkMeldrum
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  - Undecided
  20 Apr 2020 at 8:34 pm
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  1
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  The correct answer is Option A.
  
  In general, it makes sense for small or growing companies in industries characterized by a rapid change to hold cash and pay low or no dividends but it does not make sense for large, mature companies in relatively non-cyclical industries. Growth stocks need to reinvest in growth, whereas value stocks tend to generate strong free cash flow and have significantly fewer investment options.
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