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Managerial Overconfidence and Corporate Finance Policies

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  • Title:
    Managerial Overconfidence and Corporate Finance Policies
  • Author: Huang, Ronghong
  • Subjects: 150201 Finance ; CEO Overconfidence ; Corporate Debt Maturity ; Corporate Financial Leverage ; Corporate Investment ; Corporate Security Issuance ; Management Earnings Forecast ; Mergers and Acquisitions ; Miscalibration ; Optimism ; UQ Business School
  • Description: Traditional corporate finance models generally assume that agents are fully rational, but this assumption is not consistent with evidence from the psychology literature. For example, a particular type of bias, overconfidence, has been shown to have a substantial impact on various corporate decisions. Accordingly, this thesis aims to contribute to the fast- rowing behavioral corporate finance literature by focusing on how overconfidence affects corporate finance policies. There are two types of overconfidence: (1) optimism and (2) miscalibration. Optimism is defined as agents' overestimation of the mean for uncertain distributions, whereas miscalibration is defined as agents' underestimation of variance.In the first study, I examine how CEO optimism affects corporate debt maturity choices. I first develop a simple model to illustrate that optimistic CEOs prefer more short-term debt and then empirically examine this prediction. Consistent with a demand-side story, I find that firms with optimistic CEOs tend to adopt a shorter debt maturity structure by using a higher proportion of short-term debt (due within 12 months). This behavior of optimistic CEOs is not deterred by the high liquidity risk associated with such a financing strategy. The demand-side explanation remains robust even after considering six alternative drivers, including a competing supply-side explanation in which creditors are reluctant to extend long-term debt to optimistic CEOs.Due to the lack of a reliable measure for the second type of overconfidence, miscalibration, researchers are normally constrained from empirically examining the impact of miscalibration on corporate finance policies. In the second study, I develop accessible empirical measures to disentangle optimism and miscalibration through a novel exploitation of earnings forecasts issued by firm managers. Optimism is proxied by the earnings forecast error, whereas miscalibration is derived from the earnings forecast interval, after controlling for confounding factors. The resulting measures capture different aspects of the link between overconfidence and managerial decisions. In terms of investment, miscalibrated CEOs are more likely to scale up investment in real assets (especially via mergers and acquisitions); firms with optimistic CEOs display no such proclivity.In the third study, leveraging the overconfidence measures developed in the second study, I examine whether and to what extent optimism and miscalibration affect debt-equity choices differently. This study is important because the various types of overconfidence can have countervailing implications for debt or equity choices based on alternative capital structure theories. I show that firms with miscalibrated CEOs are more likely to issue debt both conditional and unconditional on accessing the external financing market, resulting in a greater increase in leverage. I further show that miscalibrated CEOs' reluctance to issue equity is attenuated by higher stock valuation. In contrast, firms with optimistic CEOs are found to have higher leverage and to increase leverage more aggressively. The results support the important roles of both optimism and miscalibration in corporate financing decisions. Source: TROVE
  • Creation Date: 2017
  • Language: English
  • Source: Trove Australian Thesis (Full Text Open Access)
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