The Role of Managerial Overconfidence in the Design of Debt Covenants

52 Pages Posted: 27 Apr 2010 Last revised: 29 Apr 2010

Jayanthi Sunder

University of Arizona - Eller College of Management

Shyam V. Sunder

University of Arizona - Department of Accounting

Liang Tan

George Washington University - Department of Accountancy

Date Written: March 1, 2010

Abstract

We examine the influence of behavioral characteristics on the design of debt covenants. We find that firms with overconfident CEOs face tighter restrictions on their ability to make future investments, acquisitions, and raise additional debt financing. These restrictions are partially mitigated when firms with overconfident CEOs have greater information transparency, a better performance record, and investment opportunities. Interestingly, we find only weak evidence for the effects on cost of debt. Overall, our study highlights the role of debt covenants in mitigating the effects of behavioral characteristics incremental to other firm and CEO specific factors documented in the prior literature.

Keywords: Overconfidence, Debt Contracting, Debt Covenants, Stock Options

JEL Classification: D82, G14, G32, G34, M52

Suggested Citation

Sunder, Jayanthi and Sunder, Shyam V. and Tan, Liang, The Role of Managerial Overconfidence in the Design of Debt Covenants (March 1, 2010). Available at SSRN: https://ssrn.com/abstract=1595007 or http://dx.doi.org/10.2139/ssrn.1595007

Jayanthi Sunder

University of Arizona - Eller College of Management ( email )

Tucson, AZ 85721
United States
520-626-8489 (Phone)

Shyam Vallabhajosyula Sunder (Contact Author)

University of Arizona - Department of Accounting ( email )

301V McClelland Hall
1130 E Helen St
Tucson, AZ 85721
United States

Liang Tan

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

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