Overconfidence, Managerial Optimism, and the Determinants of Capital Structure

Abstract

This research examines the determinants of the capital structure of firms introducing a behavioral perspective that has received little attention in corporate finance literature. The following central hypothesis emerges from a set of recently developed theories: firms managed by optimistic and/or overconfident people will choose more levered financing structures than others, ceteris paribus. We propose different proxies for optimism/overconfidence, based on the manager’s status as an entrepreneur or non-entrepreneur, an idea that is supported by theories and solid empirical evidence, as well as on the pattern of ownership of the firm’s shares by its manager. The study also includes potential determinants of capital structure used in earlier research. We use a sample of Brazilian firms listed in the Sao Paulo Stock Exchange (Bovespa) in the years 1998 to 2003. The empirical analysis suggests that the proxies for the referred cognitive biases are important determinants of capital structure. We also found as relevant explanatory variables: profitability, size, dividend payment and tangibility, as well as some indicators that capture the firms’ corporate governance standards. These results suggest that behavioral approaches based on human psychology research can offer relevant contributions to the understanding of corporate decision making.

Keywords

• capital structure
• behavioral finance
• cognitive bias
• overconfidence
• optimism
• corporate finance