Chartered Financial Analyst Level 2

Explanation

Increasing internally financed cash dividends is the most effective way to constrain management's ability to overinvest in negative NPV projects because:

• Cash dividends directly reduce the cash available to management for investment
• Internally financed means using retained earnings rather than external financing
• This forces management to be more disciplined about capital allocation decisions

Other options:

• Stock dividends don't reduce cash available to management
• EBITDA coverage requirements relate to debt capacity, not directly constraining investment decisions

This approach aligns with the free cash flow theory where returning cash to shareholders reduces agency costs.