Institutional Dual Holdings and Risk Shifting: Evidence from Corporate Innovation

Abstract

This paper analyzes the impact of shareholder-creditor conflicts on corporate risk-taking. In particular, I examine the role played by institutional dual-holders (i.e., those simultaneously holding a same firm's debt and equity) in corporate innovation. Baseline results show that firms held by dual-holders generate fewer but more valuable patents. To establish causality, I use a difference-in-differences approach based on the quasi-natural experiment of financial institution mergers. The evidence is consistent with the hypothesis that institutional dual-holders can mitigate shareholder-creditor conflicts and thus curb excessive risk-taking. I further find that the decreased sensitivity of managerial compensation to firm risk might be one possible channel through which dual-holders affect risk shifting. Overall, the paper offers new evidence that shareholder-creditor conflicts indeed exist and lead to risk shifting (asset substitution), and that institutional dual ownership can partially mitigate this problem.