Testing Trade-Off and Pecking Order Predictions about Dividends and Debt

Previous empirical work on adverse consequences of CEO overconfidence raises the question of why firms hire overconfident managers. Theoretical research suggests a reason: overconfidence can benefit shareholders by increasing investment in risky projects. Using options- and press-based proxies for CEO overconfidence, we find that over the 1993–2003 period, firms with overconfident CEOs have greater return volatility, invest more in innovation, obtain more patents and patent citations, and achieve greater innovative success for given research and development expenditures. However, overconfident managers achieve greater innovation only in innovative industries. Our findings suggest that overconfidence helps CEOs exploit innovative growth opportunities.

https://mpra.ub.uni-muenchen.de/22425/2/MPRA_paper_22425.pdf

Are Overconfident CEOs Better Innovators

https://www.research.manchester.ac.uk/portal/files/45984177/CEO_gender_02222016.pdf

CEO gender, corporate risk-taking, and the efficiency of capital allocation

Taxes, bankruptcy costs, transactions costs, adverse selection, and agency conflicts have all been advocated as major explanations for the corporate use of debt financing. These ideas have often been synthesized into the trade-off theory and the pecking order theory of leverage. These theories and the related evidence are reviewed in this survey. A number of important empirical stylized facts are identified. To understand the evidence, it is important to recognize the differences among private firms, small public firms and large public firms. Private firms seem to use retained earnings and bank debt heavily. Small public firms make active use of equity financing. Large public firms primarily use retained earnings and corporate bonds. The available evidence can be interpreted in several ways. Direct transaction costs and indirect bankruptcy costs appear to play important roles in a firm's choice of debt. The relative importance of the other factors remains open to debate. No currently available model appears capable of simultaneously accounting for all of the stylized facts.

Trade-Off and Pecking Order Theories of Debt

How do individuals form expectations about future inflation? We propose that individuals overweight inflation experienced during their lifetimes. This approach modifies existing adaptive learning models to allow for age-dependent updating of expectations in response to inflation surprises. Young individuals update their expectations more strongly than older individuals since recent experiences account for a greater share of their accumulated lifetime history. We find support for these predictions using 57 years of microdata on inflation expectations from the Reuters/Michigan Survey of Consumers. Differences in experiences strongly predict differences in expectations, including the substantial disagreement between young and old individuals in periods of highly volatile inflation, such as the 1970s. It also explains household borrowing and lending behavior, including the choice of mortgages. JEL Codes: E03, G02, D03, E31, E37, D84, D83, D14.

/pdf/learning-from-inflation-experiences-l7ayauamlq.pdf

Learning from Inflation Experiences

We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions beyond traditional capital-structure determinants First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity Such overconfident managers use less external finance and, conditional on accessing risky capital, issue less equity than their peers Second, CEOs with Depression experience are averse to debt and lean excessively on internal finance Third, CEOs with military experience pursue more aggressive policies, including heightened leverage Complementary measures of CEO traits based on press portrayals confirm the results

Overconfidence and Early-life Experiences: The Impact of Managerial Traits on Corporate Financial Policies

We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity financing. Such overconfident managers use less external finance and, conditional on accessing external capital, issue less equity than their peers. Second, CEOs who grew up during the Great Depression are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.

/pdf/overconfidence-and-early-life-experiences-the-impact-of-58yqzwfznd.pdf

We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity. Such overconfident managers use less external finance and, conditional on accessing external capital, issue less equity than their peers. Second, CEOs who grew up during the Great Depression are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.

https://papers.ssrn.com/sol3/Delivery.cfm/nber_w15659.pdf?abstractid=1537777&mirid=5

Overconfidence and Early-Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies

We argue that individual characteristics of managers can explain capital structure decisions like debt conservatism and pecking-order financing choices. Moreover, they can explain cross-sectional variation in these decisions despite identical firm characteristics. We link the reluctance of (some) managers to access external capital markets, and in particular equity markets, to managerial overconfidence. Overconfident managers believe that their company is undervalued. We test the overconfidence hypothesis, using several measures of managerial overconfidence. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company-specific risk. We also classify CEOs based on their characterization in the business press. We find that overconfident CEOs are significantly less likely than other CEOs to issue equity, conditional on tapping public securities markets. Likewise, they issue roughly 30 cents more debt to cover an additional dollar of external financing deficit than their peers. Finally, overconfident CEOs access all external capital markets (including debt markets) more conservatively.

/pdf/corporate-financial-policies-with-overconfident-managers-385pnk093s.pdf

Corporate Financial Policies With Overconfident Managers

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.

Jonathan Yan

Papers

Overconfidence and Early-life Experiences: The Impact of Managerial Traits on Corporate Financial Policies

Overconfidence and Early-life Experiences: The Impact of Managerial Traits on Corporate Financial Policies

Overconfidence and Early-Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies

Corporate Financial Policies With Overconfident Managers

Corporate Financial Policies With Overconfident Managers