Corporate Financial Policies with Overconfident Managers
University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)
Geoffrey A. Tate
University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School
affiliation not provided to SSRN
NBER Working Paper No. w13570
Many financing choices of US corporations remain puzzling even after accounting for standard determinants such as taxes, bankruptcy costs, and asymmetric information. We propose that managerial beliefs help to explain the remaining variation across and within firms, including variation in debt conservatism and in pecking-order behavior. Managers who believe that their company is undervalued view external financing as overpriced, especially equity financing. As a result, they display pecking-order preferences for internal financing over debt and for debt over equity. They may also exhibit debt conservatism: While they prefer debt to equity, they still underutilize debt relative to its tax benefits. We test these hypotheses empirically, using late option exercise by the CEO as a measure of overconfidence. We find that, conditional on accessing public markets, CEOs who personally overinvest in their companies are significantly less likely to issue equity. They raise 33 cents more debt to cover an additional dollar of financing deficit than their peers. Moreover, the frequency with which they access any external finance (debt or equity) is significantly lower, resulting in debt conservatism. The results replicate when identifying managerial overconfidence based on press portrayal as confident or optimistic. We conclude that managerial overconfidence helps to explain variation in corporate financial policies.
Number of Pages in PDF File: 44working papers series
Date posted: November 5, 2007
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