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Does Distance Matter for Debtholder-Shareholder Conflicts?

We study how the geographical distance between large debtholders and large shareholders affects firms’ risk and risk-shifting incentives. We argue that greater distance reduces debtholders’ ability to observe shareholder characteristics and increases their information asymmetry vis-a-vis shareholders, thus amplifying firms’ asset substitution problems. We find that greater distance is associated with higher firm risk and greater risk-shifting activities as evidenced by a higher likelihood of covenant violation and larger dividend payouts. Moreover, stock (bond) market reactions around such risk-shifting events are positively (negatively) related to debtholder-shareholder distance. These results are more pronounced among more financially constrained firms, lower-rated firms, and firms with large shareholders that have greater preference for idiosyncratic risk. Our results are robust to using instrumental variables and the introduction of a new airline route as an exogenous shock to geographic distance.