Control Overhang and Owner Financial Constraints: Evidence From Equity Issuance

Abstract

Under the debt overhang problem, firms approaching distress issue too little equity because new capital primarily benefits creditors. We identify an additional mechanism—control overhang—that further suppresses equity issuance for firms with controlling owners. As distress risk rises, equity issuance discounts steepen, and each unit of capital raised requires greater ownership dilution. Controlling owners who cannot fund their pro rata share of a new issue risk diluting their control, making them reluctant to issue equity when it is most needed. Using comprehensive Swedish data, we show that the decline in equity issuance as default probability rises is concentrated among firms whose controlling owner is financially constrained, that is, undiversified and lacking the wealth to participate in new issues. When the controlling owner is unconstrained and can self‐fund, the effect disappears. This pattern is predicted by control overhang but not by debt overhang, which operates regardless of owner characteristics.