Corporate Financing of Investment Opportunities in a World of Institutional Cross-Ownership
64 Pages Posted: 8 Jun 2018 Last revised: 15 Jun 2020
Date Written: June 2020
Public firms are becoming increasingly interconnected through institutional investors’ stock ownership, specifically through cross-ownership, in which an institutional investor has a significant stake in multiple firms in the same industry. When a firm seeks external financing for its investment opportunities, information asymmetry arises between the firm and capital providers, which raises concerns about adverse selection pre-financing and moral hazard post-financing. Consistent with institutional cross-owners reducing such concerns, we find that cross-ownership facilitates the external financing of investment opportunities of these firms. We then examine conditions under which the role of cross-owners is likely to be greater in reducing adverse selection and moral hazard. We document that cross-ownership facilitates financing even more for firms in an opaque financial reporting environment, those facing more product market competition, and those with dedicated institutional cross-owners. We also provide supplementary evidence that cross-ownership is associated with a lower cost of capital and higher corporate investment. Our paper offers insight into the role of cross-ownership in reducing moral hazard and adverse selection from a corporate financing perspective.
Keywords: Cross-ownership; Information advantage; Investment opportunities; Corporate financing; Adverse selection; Moral hazard
JEL Classification: G10, G23, G32
Suggested Citation: Suggested Citation