relevant to the extent that shark repellent-adopting ﬁrms can be characterized by
relatively high levels of capital spending and R&D investment.
The potential relevance of dividend policy and capital structure decisions is
suggested by Jensen’s (1986) free cash ﬂow hypothesis, which recognizes high
dividend payout ratios and high debt-to-equity (leverage) ratios as effective
means for controlling the agency costs of free cash ﬂow. If the self-interested
management of shark repellent-adopting ﬁrms is typically insulated from market
discipline, a signiﬁcant amount of slack should be observed in these commonly
employed corporate control mechanisms. Thus, the managerial-entrenchment
hypothesis would predict relatively low dividend payout ratios and low leverage
for shark repellent-adopting ﬁrms during the pre- and postadoption periods.
Conversely, if shark repellents are adopted by ﬁrms with managers who are
highly motivated to maximize shareholder value, high dividend payout ratios and
high leverage should be typical. It follows that effective constraints on the agency
costs of free cash ﬂow during the pre- and postadoption periods are consistent
with the competing shareholder-interest hypothesis. By considering the link
between shark repellent adoptions, investment policy, dividend policy, and lever-
age during the pre- and postadoption periods, it becomes possible to arrive at
some discriminating evidence concerning the predictive capability of the man-
agement-entrenchment and shareholder-interest hypotheses.
IV. MEASURES OF LONG-TERM PERFORMANCE AND
The cash ﬂow margin on sales reﬂects the ability of the ﬁrm to generate a proﬁt
contribution on each dollar of sales revenue. Following Healy, Palepu, and
Ruback (1992), the cash ﬂow margin on sales (CFMS
) employed in this study is
is cash ﬂow deﬁned as net income plus depreciation.
This cash ﬂow-
based measure of proﬁtability is used rather than a more traditional approach in
order to minimize the inﬂuences of accrual accounting conventions and ﬁrm-by-
ﬁrm differences in accounting policy choice decisions. Whereas a high cash ﬂow
margin indicates a commensurately high rate of operating efﬁciency, a low cash
ﬂow margin on sales can reﬂect the fact that expenses are out of control. Of
course, the cash ﬂow margin on sales is related to the effectiveness of the ﬁrm’s
operating policies and to the vigor of industry competition.
210 CHAPTER 9 SHARK REPELLENTS AND RESEARCH AND DEVELOPMENT
From Compustat, INC_DEP (Compustat item #13) is used for income before depreciation, and
DEPREC (Compustat item #14) is used for depreciation.