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

See all articles by Sewon Kwon

Sewon Kwon

Ewha Womans University-School of business

Jae Hwan Ahn

Lancaster University - Department of Accounting and Finance

Gi H. Kim

Warwick Business School - University of Warwick

Date Written: March 25, 2021

Abstract

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

Kwon, Sewon and Ahn, Jae Hwan and Kim, Gi Hyun, The Impact of Shareholder Intervention on Overinvestment of Free Cash Flow by Overconfident CEOs (March 25, 2021). International Review of Financial Analysis, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3812694

Sewon Kwon

Ewha Womans University-School of business ( email )

52 Ewhayeodae-gol, Seodaemun-gu
Ewha-Shinsegae #404
Seoul
Korea, Republic of (South Korea)

Jae Hwan Ahn (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Gi Hyun Kim

Warwick Business School - University of Warwick ( email )

Coventry CV4 7AL
United Kingdom
+44 (0)24 7652 3849 (Phone)

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