Einfluss von Overconfidence und Optimismus von Finanzvorständen auf ihre Kapitalstrukturentscheidungen

  • CFO overconfidence, optimism, and corporate financing

Kasch, Michael Georg; Brettel, Malte (Thesis advisor)

Aachen : Publikationsserver der RWTH Aachen University (2009)
Dissertation / PhD Thesis

Aachen, Techn. Hochsch., Diss., 2008


Economists typically assume that agents behave rationally. Yet a large and growing body of research in experimental psychology reports that people frequently depart from perfect rationality: people tend to be excessively overconfident and optimistic. Such behavioral aspects recently also enter the corporate finance literature. Intriguing work by Bertrand and Schoar (2003) shows empirically that a significant part of the heterogeneity in financial, investment, and organizational practices of firms can be explained by the presence of manager fixed effects. But the corporate finance literature hardly explains how specific managerial traits influence corporate financing decisions. In a recent working paper Hackbarth (2004) shows how managerial overconfidence and optimism affect capital structure. Yet literature lacks of empirical evidence. We contribute to this strand of literature by testing empirically the resulting hypothesis that overconfident and optimistic managers choose higher debt levels than unbiased managers. Hackbarth (2004) draws on the findings of De Long, Shleifer et al. (1991) that overconfident managers underestimate the riskiness of cash flows, while optimistic managers overestimate the growth rate of cash flows. This results in biased managers choosing higher debt levels than unbiased managers. However, Hackbarth (2004) concludes that managerial overconfidence and optimism may still enhance firm value. Accordingly, the manager’s capital structure decision balances the perceived values of tax benefits, default costs, and self-interest with the need to ensure sufficient efficiency to prevent control challenges (e.g., due to simple tax arbitrage) at any particular time. Inefficiently low leverage choices (e.g., due to rational self-interest or entrenchment) are less pronounced for overconfident and optimistic managers. Hence, biased managers make capital structure decisions that are more in the interest of shareholders than those of rational managers. The overconfidence and optimism story builds upon prominent stylized facts from the social psychology literature, the "narrow confidence intervals" and the "better than average" effect. Miscalibrated people form probability distributions over uncertain quantities that are too tight (Lichtenstein, Fischhoff et al. (1982)). In studies that analyze assessments of uncertain quantities people are asked to answer questions with two alternative answers. Afterwards, they are asked to state the probability that their answer is correct. The usual finding is that for all questions which where assigned with a given probability the proportion of correct answers is lower than the assigned probability (Lichtenstein, Fischhoff et al. (1982)). When individuals assess their relative skills, they tend to overstate their acumen relative to the average (Larwood and Whittaker (1977); Svenson (1981); Alicke (1985)). This effect extends to economic decision-making in experiments (Camerer and Lovallo (1999)). It also affects the attribution of causality. Because individuals expect their behavior to produce success, they are likely to attribute good outcomes to their actions, but bad outcomes to (bad) luck (Miller and Ross (1975)). Executives appear to be particularly prone to display overconfidence and optimism, both in terms of the "narrow confidence intervals" and in terms of "better-than-average effect" (Larwood and Whittaker (1977); Kidd (1970); Moore (1977)). This finding is attributed to three main factors, which trigger overconfidence and optimism: the illusion of control, a high degree of commitment to good outcomes, and abstract reference points that make it hard to compare performance across individuals (Weinstein (1980); Alicke and Klotz (1995)). All three factors are pertinent in the context of corporate financing. Survey evidence compiled by Graham and Harvey (2001) indicates that most executives typically believe that, despite uncertainty they can control the impact of their financing decisions on corporate performance. The typical CFO is also highly committed to good company performance since his personal wealth and the value of his human capital fluctuate with the company’s stock price. And finally, assessing relative managerial skill or, specifically, the ability to choose the optimal debt level is difficult - even ex post - due to other factors that influence overall firm performance. We directly test the hypothesis that managerial overconfidence and optimism increase corporate leverage by regressing several measures of leverage on the individual overconfidence and optimism scores of the respective CFOs. We conduct a survey among 469 CFOs of listed German companies. In designing the questionnaire we closely follow the concepts and experimental set-up in the psychological literature. Unfortunately, such a comprehensive approach typically reduces response rates since the questions might be considered as too intimate. The CFOs are asked to answer a questionnaire which was designed to measure the various facets of overconfidence and optimism. The measures of leverage were calculated for the companies of the CFOs who answered the questionnaire. We find that CFOs’ overconfidence leads to higher leverage of their respective company. Moreover we find that overconfidence and optimism are two different personal traits and differ in the way they influence financial decisions because we fail to show a significant effect of optimism on leverage. Finally managerial overconfidence as well as optimism is independent from other personal characteristics such as age or education. Our results thereby support the hypothesis that overconfidence can enhance firm value by leading to financing decisions which are more in the interest of shareholders than rational managers’ decisions do. Therefore this paper’s recommendation for corporate practice is that shareholders must draw a fine line between taking advantage and disvantage of predictable biases of their agents. Compared with prior research on the role of managerial biases on corporate decision making our research differs in significant ways. First, we examine the influence of managerial traits on corporate financing decsions whereas the impact of managerial biases on investment decisions yet is well documented. Heaton (2002) analyzes the effect of managerial optimism on the benefits and costs of free cash flows. Malmendier and Tate (2004) empirically show that managerial overconfidence can account for investment-cash flow sensitivity. Second, by analyzing the influence of certain personal traits, overconfidence and optimism, on capital structure decisions we specify the finding of Bertrand and Schoar (2003). They show that a significant part of the heterogeneity in financial practices of firms can be explained by the presence of unspecified manager fixed effects. Thereby we are able to derive relevant advice for corporate practice. Third, by closely following the concepts and experimental set-up in the psychological literature in our survey for measuring overconfidence and optimism we provide empirical evidence not depending on proxies. In Malmendier and Tate (2004) stock option exercise decisions of managers are used as a proxy for overconfidence. Landier and Thesmar (2003) use the comparison of entrepreneurs’ growth expectations with the actual growth as a proxy for optimism.


  • Innovation und Entrepreneurship Group (WIN) [813110]