Leverage Capability in Controlling Free Cash Flow to Improve Financial Performance Nila Tristiarini Faculty of Economics and Business University of Dian Nuswantoro Semarang, Indonesia nila.tristiarini@dsn.dinus.ac.id Ririh Dian Pratiwi Faculty of Economics and Business University of Dian Nuswantoro Semarang, Indonesia ririh.dian.pratiwi@dsn.dinus.ac.id Abstract— Free Cash Flow, in general, being a problem for the company if it is not good in controlling. The manager can use free cash flow for actions that can harm the company. Leverage is a cost that can control the usage of free cash flow for the company's activity, which in turn can improve financial performance. The purpose of this study is to examine the role of leverage in mediating the relationship between free cash flow and financial performance. The research variable consists of Free Cash Flow as the independent variable, the Leverage as the mediator and Financial Performance as the dependent variable. The population of this research is manufacturing companies listed on the Indonesia Stock Exchange periods 2011-2015. The sampling method is purposive sampling with criteria, and the samples that meet the criterion are 70 manufacturing companies. The research model is used Warp PLS 3.0. The results show that free cash flow has an effect on financial performance, and Leverage mediates the relationships between free cash flow and financial performance. This research contribute a novelty of science in the field of management accounting, and has positive implications for companies in determining control strategies of free cash flow through the leverage could improve the financial performance. Keywords— Leverage, Free Cash Flow, Financial Performance I. INTRODUCTION Theory of the firm Jensen & Meckling [16], stated that the company's primary goal is profit maximization for shareholders. All corporate activities are intended to meet the interests of shareholders. Companies can make profit maximization if can control and manage the finance to improve financial performance. Free Cash Flow is one tool to measure the company's financial performance and show the amount of cash owned by the company after performing maintenance or development costs of the required assets [1], [11]. Free Cash Flow is an important application for shareholders in assessing the financial health of the company. Managers who invest in Free Cash Flow in projects with today's positive net worth (NPV) as a result of efficient use of their resources will contribute to the increase in corporate value. When it cannot control free cash flow properly, it can otherwise lower the value of the company. Differences in the concept of free cash flow control can occur because of differences in control and ownership of a company, i.e., the manager's interests and shareholders, causing agency problems [16]. After observing agency issues, Jensen [16] used agency theory as a starting point for proposing a free cash flow hypothesis. According to this hypothesis, corporate managers prefer to have free cash flow that they easily manipulate. They tend to use free cash flow for their benefit rather than the interests of shareholders. Managers prioritize their interests, making the wrong spending or decisions that result in losses known as agency costs that negatively impact the company's performance. According to the free cash flow hypothesis, a negative correlation exists between the firm's performance and the amount of free cash flow under manager control [13]. Titman, et al [24] and Dechow, et al [19] argued that company performance negatively affected by overinvestment in the use of free cash flow under manager control. The work of Park and Jang [13], Heydari et al. [9], Brush et al. [27] and Wang [7] also reveal a negative correlation between performance and free cash flow. Free cash flow can be controlled one of them through debt financing. Debt financing will reduce the cash flow that ultimately has a positive effect on the performance of the company. It is in accordance with the results of research conducted by Rozeff [18] and Easterbrook [5] who found that debt financing is needed to lower agency costs as reflected in free cash flow. The company's funding decision concerns the decision on the shape and composition of funding to be used by the company [6]. In general, funds can be obtained from outside the company (external financing) and from inside the company (internal financing). Debt is funding obtained from external financing [21]. Debt is all financial obligations of a company that has not been fulfilled to other parties, where the debt is a source of funds or capital of a company. Debt is a liability of a company arising from past transactions and payments made by cash or goods, and services in the future. According to Taani [14], that debt is an economic sacrifice that the company must make in the future due to previous actions or transactions. The economic sacrifice can be in the form of money, assets, services, or by doing a particular job. Debt results in a bond that entitles the creditor to claim the company's assets. Copyright © 2018, the Authors. Published by Atlantis Press. This is an open access article under the CC BY-NC license (http://creativecommons.org/licenses/by-nc/4.0/). 184 Advances in Economics, Business and Management Research (AEBMR), volume 46 1st Economics and Business International Conference 2017 (EBIC 2017)