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.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13570.
Length: Date of creation: Nov 2007 Date of revision: Handle: RePEc:nbr:nberwo:13570
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Find related papers by JEL classification: D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information D9 - Microeconomics - - Intertemporal Choice and Growth E26 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy G3 - Financial Economics - - Corporate Finance and Governance G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure H40 - Public Economics - - Publicly Provided Goods - - - General H41 - Public Economics - - Publicly Provided Goods - - - Public Goods
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Myers, Stewart C., 1984.
"Capital structure puzzle,"
Working papers
1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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