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Capital Structure Decisions, Loss Aversion, and Equity Premium

Author

Listed:
  • Wolfgang Breuer
  • Ji Cao
  • Marc Oliver Rieger
  • K. Can Soypak

Abstract

Previous studies suggest that equity is sold at a premium in capitalmarkets and behavioral economists attribute this equity premium puz-zle to investors’ loss aversion. The market timing literature argues thatmarket evaluation of equity affects capital structure decisions of firms.Combining the two strands, we theoretically and empirically show thatinvestors’ loss aversion positively affects the leverage of firms. The ef-fect is robust to alternative regression approaches, definitions of lever-age, subperiods, and subsamples. The positive relation between lossaversion and leverage vanishes for firms with high bankruptcy risks,with high foreign holdings, or with high institutional holdings. Con-trolling for additional preferences and cultural variables does not sub-due the effect. Thus, unlike previous studies, we not only discusswhether mispricing of external financing instruments affects capitalstructure, but we elaborate on the reasons that generate mispricing inthe first place.

Suggested Citation

  • Wolfgang Breuer & Ji Cao & Marc Oliver Rieger & K. Can Soypak, 2019. "Capital Structure Decisions, Loss Aversion, and Equity Premium," Working Paper Series 2019-04, University of Trier, Research Group Quantitative Finance and Risk Analysis.
  • Handle: RePEc:trr:qfrawp:201904
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    More about this item

    Keywords

    Capital Structure; Loss Aversion; Equity Premium; Lever-age; Bankruptcy Risk;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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