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Corporate Financial Policies With Overconfident Managers

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  • Ulrike Malmendier
  • Geoffrey Tate
  • Jonathan Yan

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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13570.

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Date of creation: Nov 2007
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Publication status: published as Overconfidence and Early - life Experiences: The Effect of Managerial Traits on Corporate Financial Policies (with G. Tate and J. Yan). Journal of Financ e , October 2011, vol. 66(5) , pp. 1687 - 1733.
Handle: RePEc:nbr:nberwo:13570

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Cited by:
  1. Elsas, Ralf & Florysiak, David, 2008. "Empirical Capital Structure Research: New Ideas, Recent Evidence, and Methodological Issues," Discussion Papers in Business Administration, University of Munich, Munich School of Management 4743, University of Munich, Munich School of Management.
  2. Koudijs, Peter & Voth, Hans-Joachim, 2014. "Leverage and Beliefs: Personal Experience and Risk Taking in Margin Lending," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9920, C.E.P.R. Discussion Papers.
  3. Ezzeddine Ben Mohamed & Baccar Ame & Abdelfatteh Bouri, 2013. "Investment Cash Flow Sensitivity and Managerial Optimism: A Literature Review via the Classification Scheme Technique," The Review of Finance and Banking, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, vol. 5(1), pages 007-026, June.
  4. Kamal Anouar, 2013. "L'Exces De Confiance Des Dirigeants Et La Decision De Distribution De Dividendes : Une Analyse Lexicale," Working Papers, HAL halshs-00797635, HAL.
  5. Jijun Niu, 2010. "The Effect of Overconfidence on the Sensitivity of CEO Wealth to Equity Risk," Journal of Financial Services Research, Springer, Springer, vol. 38(1), pages 23-39, August.
  6. AZOUZI Mohamed Ali & JARBOUI Anis, 2013. "Why CEO Emotional Biases Affect Firm Assets Specificity Choice Bayesian Network Method: The Evidence from Tunisia," Asian Journal of Empirical Research, Asian Economic and Social Society, Asian Economic and Social Society, vol. 3(3), pages 329-350, March.
  7. Sandra Ludwig & Julia Nafziger, 2011. "Beliefs about overconfidence," Theory and Decision, Springer, Springer, vol. 70(4), pages 475-500, April.
  8. Sandra Ludwig & Julia Nafziger, 2007. "Do You Know That I Am Biased? An Experiment," Bonn Econ Discussion Papers, University of Bonn, Germany bgse11_2007, University of Bonn, Germany.
  9. Campbell, T. Colin & Gallmeyer, Michael & Johnson, Shane A. & Rutherford, Jessica & Stanley, Brooke W., 2011. "CEO optimism and forced turnover," Journal of Financial Economics, Elsevier, Elsevier, vol. 101(3), pages 695-712, September.

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