Corporate Financial Policies With Overconfident Managers

Ulrike Malmendier (), Geoffrey Tate and Jonathan Yan

No 13570, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: D23 D53 D82 D9 E26 G3 G31 G32 H40 H41 (search for similar items in EconPapers)
Date: 2007-11
Note: CF LS
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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.

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