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Agency Costs of Debt and Composition of Institutional Ownership
Scott W Liao,
The Ohio State University
ABSTRACT. This paper examines how the composition of institutional ownership affects agency costs of debt. The results show that firms predominantly owned by dedicated investors face higher LIBOR spreads and use “sweep covenants” more often. This result suggests that dedicated investors’ intervention in corporate governance decisions increases management’s preference for risk taking, thereby increasing debtholders’ concern over asset substitution problems. In addition, firms that have predominant transient ownership also face higher LIBOR spreads and tend to include both “sweep” and net worth covenants in debt contracts. This suggests that debtholders are concerned not only with these firms’ asset-substitution/overinvestment problems but also with unauthorized distribution problems induced by transient investors’ short-term investment horizons and lack of incentives to monitor management. This paper extends the literature on the relation between institutional ownership and firm investments.
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