Inattention, Agency Conflicts, and the Cost of Debt

Abstract

We examine whether inattention in the equity market provides predictive information to investors in the bond market. Using a new measure of shareholder inattention based on exogenous industry shocks to institutional investor portfolios, we find a positive and significant relation between firms with distracted institutional shareholders and the cost of debt financing. This effect is stronger for firms with more powerful CEOs, firms with higher information asymmetries, and firms operating in less competitive product markets. Additional analysis suggests mechanisms that reduce the bondholder-shareholder conflict — namely, institutional dual holders and bond covenants — attenuate the increase in bond yield spreads resulting from greater shareholder distraction. In contrast to the institutional shareholder setting, we find little evidence of differences in yield spreads associated with retail investor inattention using search frequency in Google. Our findings are robust to controlling for the presence of other external monitors such as credit rating agencies, institutional investors, financial analysts, and Big 4 auditors. Overall, these results suggest that shareholder inattention in the equity market is consequential to investors in the bond market.

Keywords: Inattention, Agency Conflicts, Bondholder–Shareholder Conflict, Cost of Debt

JEL Classification: G23, G34