Does inside debt help mitigate agency problems? The case with investment inefficiency and payout policies

Abstract

Although the literature has established that CEO inside debt induces risk aversion, it remains inconclusive whether these CEOs increase firm payout or not. While some studies show that high inside debt CEOs increase firm payout to avoid risky projects, others document that they reduce payout to preserve funds. This study addresses this contradiction by examining a sample of U.S. firms over the 2006–2018 period. Consistent with the agency theory, our results show that CEOs with larger inside debt adjust payout policies to mitigate prior overinvestment. Specifically, they increase payout in the subsequent period if their firm is already overinvested.