The role of the dual holder in mitigating underinvestment

The literature on dual holding focuses exclusively on cases where the holder is primarily a creditor and buys the firm's stocks to reduce potential wealth transfer. However, wealth transfer is not a concern when the dual holder is a stockholder first and becomes a bondholder later. We hypothesize that the principal motive behind such dual holdings is to provide debt funding to an otherwise successful firm that cannot fund good projects because of internal capital allocation problems coupled with external capital constraints. We select samples from multinational corporations based on evidence that these firms are exposed to domestic underinvestment because they are reluctant to bring back foreign profits to avoid repatriation taxes. We choose hedge funds (HFs) as dual holders. The treatment group comprises firms where HFs are dual owners, and the control group comprises firms in which HFs own stocks only. The treatment group experiences steeper financial constraints, leading to deeper underinvestment problems and causing target firms to seek HF funding. The funding corresponds well to the amount of underinvestment. Targets improve investment efficiency by alleviating underinvestment, surpassing their predual performance and the control group's postdual performance.