CEO Inside Debt and Overinvestment

Abstract

Theoretical studies suggest that overinvestment is driven by equity holders’ desire to shift wealth from debt holders, while underinvestment is driven by equity holders’ desire to prevent the enhancement of debt-holder wealth. Therefore, debt holders have a stronger incentive to eliminate overinvestment than to eliminate underinvestment. We find that firms with higher inside-debt ratios are less likely to overinvest. Firms with above-median CEO inside-debt ratios drive this negative effect. These results support our expectation that CEO inside debt serves as a curb on overinvestment in order to prevent a wealth shift from debt holders to equity holders.