Overpayment, Financial Distress, and Investor Horizons

Firms that follow excessive payout policies (over-payers) have significantly higher financial distress risk and lower survival compared to under-payers, consistent with risk-shifting from shareholders to creditors in distressed firms. All else equal, the presence of institutional investors with long-term investment horizons in a firm is associated with overpayment. A transition analysis indicates the existence of a reciprocal relation between overpayment and financial distress, highlighting the feedback effects between overpayment and distress. In addition, over-payers endure smaller future sales and assets growth, and experience a significant future increase in the overall riskiness of their assets, compared to under-payers.