Corporate Financial Policies with Overconfident Managers

44 Pages Posted: 5 Nov 2007 Last revised: 1 Aug 2010

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)

Jonathan Yan

affiliation not provided to SSRN

Date Written: November 2007

Abstract

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.

Suggested Citation

Malmendier, Ulrike and Tate, Geoffrey A. and Yan, Jonathan, Corporate Financial Policies with Overconfident Managers (November 2007). NBER Working Paper No. w13570, Available at SSRN: https://ssrn.com/abstract=1027189

Ulrike Malmendier (Contact Author)

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

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University of California, Berkeley - Haas School of Business ( email )

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Geoffrey A. Tate

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

MD
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jonathan Yan

affiliation not provided to SSRN

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