Influence of Leverage on the Relationship Between Institutional Investors and Performance: Productivity and Financial Performance of Saudi Listed Firms

In this paper, we aim to evaluate how leverage would reshape the effect of institutional investors on mitigating agency cost and enhancing productivity and financial performance of Saudi manufacturing listed firms over the period 2010–2020. Additionally, we aim to construct an optimal financial frontier that captures the accounting and market sides of performance using the stochastic output distance function (ODF) approach. We used the stochastic frontier approach (SFA) to estimate the production frontier. Our findings suggest institutional investors positively impact firms’ productivity and financial performance. However, this positive effect weakens as the level of leverage increases. Our results indicate that institutional investors and leverage act as substitutive monitoring devices to mitigate agency costs and enhance firms’ performance. From a policy perspective, to reduce agency costs and improve firm performance, policymakers may find it optimal to recommend using a lower level of debt and encourage institutional investors as a monitoring device.