The Impact of Shareholder Intervention on Overinvestment of Free Cash Flow by Overconfident CEOs
49 Pages Posted: 26 Mar 2021 Last revised: 7 Apr 2021
Date Written: March 25, 2021
This paper examines the impact of shareholder intervention on investment distortions, which we capture using overinvestment of free cash flow by overconfident CEOs. Using this definition and U.S. data for 1996–2014, our fixed effects and difference-in-difference matching estimation results provide consistent evidence that the threat of potential intervention of shareholders can curb overinvestment by overconfident CEOs. Specifically, firms with greater voting premium and hedge fund activism experience less overinvestment and exhibit lower sensitivity of free cash flow to investment. Such disciplining effects are stronger for firms managed by overconfident CEOs. Overall, our results suggest that shareholder intervention is particularly effective at mitigating overinvestment that is more likely to be distorted.
Keywords: investment-cash flow sensitivity, CEO overconfidence, free cash flow, investment distortion, shareholder intervention
JEL Classification: G3, M4
Suggested Citation: Suggested Citation