Institutional Shareholder Distraction, Agency Conflicts, and the Cost of Debt

Abstract

Using a new measure of shareholder inattention based on exogenous industry shocks to institutional investor portfolios, we document 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. Further analysis suggests mechanisms that reduce the bondholder-shareholder conflict—namely, bond covenants and institutional dual holders—attenuate the increase in bond yield spreads resulting from greater shareholder distraction. The results are robust to controlling for alternative measures of inattention at the retail investor level, and for the presence of other external monitors such as credit rating agencies, financial analysts, and Big 4 auditors. Overall, our evidence lends empirical support to the notion that shareholder inattention in the equity has an incrementally negative effect on bond valuation.

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

JEL Classification: G23, G34