Agency Problems in Young Firms

Abstract

We document the existence of manager-shareholder agency problems caused by excess cash in young firms. Firms receiving quasi-random cash windfalls from the exercise of the overallotment option during their IPO are more likely to make value-destroying acquisitions. We hand-collect executive compensation data for these firms and find that the CEOs of these firms receive direct pecuniary benefits in the form of higher executive compensation. We run several tests to account for the potential endogeneity of the overallotment option with respect to investment. While previous work on the free cash flow hypothesis has focused on mature firms, we show that these problems also exist in young firms.

Keywords: Free cash flow hypothesis, cash holdings, overallotment option, IPO

JEL Classification: D22, G02, G10, G31