Corporate Financial Policies With Overconfident Managers
University of California, Berkeley - Department of Economics; University of California, Berkeley - Haas School of Business; 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 Kenan-Flagler Business School; National Bureau of Economic Research (NBER)
November 5, 2005
AFA 2006 Boston Meetings Paper
We argue that individual characteristics of managers can explain capital structure decisions like debt conservatism and pecking-order financing choices. Moreover, they can explain cross-sectional variation in these decisions despite identical firm characteristics. We link the reluctance of (some) managers to access external capital markets, and in particular equity markets, to managerial overconfidence. Overconfident managers believe that their company is undervalued. They view external financing, and especially equity financing, as overpriced. We test the overconfidence hypothesis, using several measures of managerial overconfidence. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company-specific risk. We also classify CEOs based on their characterization in the business press. We find that overconfident CEOs are significantly less likely than other CEOs to issue equity, conditional on tapping public securities markets. Likewise, they issue roughly 30 cents more debt to cover an additional dollar of external financing deficit than their peers. Finally, overconfident CEOs access all external capital markets (including debt markets) more conservatively.
Number of Pages in PDF File: 58
Keywords: capital structure, behavioral corporate finance, overconfidence
JEL Classification: G32, G31
Date posted: March 23, 2005
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