Shareholder Bargaining Power, Debt Overhang, and Investment

Using a dynamic model of strategic bargaining between equity and debt holders following default, we analyze the impact of shareholder bargaining power and debt overhang on optimal investment and strategic default. Our empirical tests utilize a new measure of the debt overhang wedge based on default probabilities generated from a hazard model for bankruptcy. Consistent with the theoretical predictions, bondholder (shareholder) ownership concentration ceteris paribus enhances (weakens) the overhang wedge and dampens (increases) capital investment. We identify novel ownership-structure-related factors in firm-level capital investment and document how post-default shareholder bargaining power alleviates the underinvestment problem caused by debt overhang.