The Role of Managerial Overconfidence in the Design of Debt Covenants
52 Pages Posted: 27 Apr 2010 Last revised: 29 Apr 2010
Date Written: March 1, 2010
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: Suggested Citation