Corporate Financial Policies with Overconfident Managers*

58 Pages Posted: 8 Apr 2006

See all articles by Ulrike Malmendier

Ulrike Malmendier

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 Maryland - Robert H. Smith School of Business; National Bureau of Economic Research (NBER)

Jun Yan

Stanford University

Date Written: November 5, 2005

Abstract

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. 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.

Suggested Citation

Malmendier, Ulrike and Tate, Geoffrey A. and Yan, Jun, Corporate Financial Policies with Overconfident Managers* (November 5, 2005). 8th Annual Texas Finance Festival, Available at SSRN: https://ssrn.com/abstract=895843 or http://dx.doi.org/10.2139/ssrn.895843

Ulrike Malmendier (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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Geoffrey A. Tate

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

National Bureau of Economic Research (NBER)

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Jun Yan

Stanford University ( email )

Stanford, CA 94305
United States