Skip to main content
SpringerLink
Log in

CEO overconfidence and the adjustment speed of leverage and cash: evidence on cash is not the same as negative debt

  • Published:
Empirical Economics Aims and scope Submit manuscript

Abstract

Overconfident CEOs speed up (slow down) adjusting firm leverage if it is above (below) target leverage. In addition, overconfident CEOs speed up (slow down) adjusting firm cash holdings if it is below (above) the optimal balance. Our results imply overconfident CEOs are associated with high cash holdings and low leverage. Additional tests suggest that the results do not imply cash and (negative) debt are substitutable. We also find overconfident CEOs sometimes reduce firm leverage unexpectedly. The observation is consistent with the view that overconfident CEOs are strong-willed individuals who dislike being monitored. Thus, besides the tendency to overestimate their ability and underestimate risk, overconfident CEOs are affected by additional aspects of their behavioral traits in decision making.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. The amount raised through debt or equity issues to cover expenditures (Malmendier et al. 2011, page 1697).

References

  • Acharya VV, Almeida H, Campello M (2007) Is cash negative debt? A hedging perspective on corporate financial policies. J Financ Intermed 16(4):515–554

    Article  Google Scholar 

  • Aktas N, Louca C, Petmezas D (2019) CEO overconfidence and the value of corporate cash holdings. J Corp Finance 54:85–106

    Article  Google Scholar 

  • Baker M, Ruback RS, Wurgler J (2007) Behavioral corporate finance. In: B. Espen Eckbo (Ed) Handbook of empirical corporate finance, pp 145–186. Elsevier

  • Baskin J (1987) Corporate liquidity in games of monopoly power. Rev Econ Stat 69(2):312–319

    Article  Google Scholar 

  • Bates TW, Kahle KM, Stulz RM (2009) Why do US firms hold so much more cash than they used to? J Finance 64(5):1985–2021

    Article  Google Scholar 

  • Baum CF, Caglayan M, Rashid A (2017) Capital structure adjustments: do macroeconomic and business risks matter? Empir Econ 53:1463–1502

    Article  Google Scholar 

  • Ben-David I, Graham JR, Harvey CR (2013) Managerial miscalibration. Q J Econ 128(4):1547–1584

    Article  Google Scholar 

  • Bonini N, Pighin S, Rettore E, Savadori L, Schena F, Tonini S, Tosi P (2019) Overconfident people are more exposed to “black swan” events: a case study of avalanche risk. Empir Econ 57:1443–1467

    Article  Google Scholar 

  • Byoun S (2008) How and when do firms adjust their capital structures toward targets? J Finance 63(6):3069–3096

    Article  Google Scholar 

  • Camerer C, Lovallo D (1999) Overconfidence and excess entry: an experimental approach. Am Econ Rev 89(1):306–318

    Article  Google Scholar 

  • Campbell TC, Gallmeyer M, Johnson SA, Rutherford J, Stanley BW (2011) CEO optimism and forced turnover. J Financ Econ 101(3):695–712

    Article  Google Scholar 

  • Devos E, Rahman S, Tsang D (2017) Debt covenants and the speed of capital structure adjustment. J Corp Finance 45:1–18

    Article  Google Scholar 

  • Dittmar A, Mahrt-Smith J (2007) Corporate governance and the value of cash holdings. J Financ Econ 83(3):599–634

    Article  Google Scholar 

  • Drobetz W, Schilling DC, Schröder H (2015) Heterogeneity in the speed of capital structure adjustment across countries and over the business cycle. Eur Financ Manag 21:936–973

    Article  Google Scholar 

  • Fama EF, French KR (2002) Testing trade-off and pecking order predictions about dividends and debt. Rev Financ Stud 15(1):1–33

    Article  Google Scholar 

  • Faulkender M, Flannery MJ, Hankins KW, Smith JM (2012) Cash flows and leverage adjustments. J Financ Econ 103(3):632–646

    Article  Google Scholar 

  • Ferris SP, Jayaraman N, Sabherwal S (2013) CEO overconfidence and international merger and acquisition activity. J Financ Quant Anal 48(1):137–164

    Article  Google Scholar 

  • Flannery MJ, Rangan KP (2006) Partial adjustment toward target capital structures. J Financ Econ 79(3):469–506

    Article  Google Scholar 

  • Gervais S, Heaton JB, Odean T (2011) Overconfidence, compensation contracts, and capital budgeting. J Finance 66(5):1735–1777

    Article  Google Scholar 

  • Goel AM, Thakor AV (2008) Overconfidence, CEO selection, and corporate governance. J Finance 63(6):2737–2784

    Article  Google Scholar 

  • Graham JR, Harvey CR (2001) The theory and practice of corporate finance: evidence from the field. J Financ Econ 60(2–3):187–243

    Article  Google Scholar 

  • Hackbarth D (2008) Managerial traits and capital structure decisions. J Financ Quant Anal 43(4):843–881

    Article  Google Scholar 

  • Hall BJ, Murphy KJ (2002) Stock options for undiversified executives. J Account Econ 33(1):3–42

    Article  Google Scholar 

  • Hiller NJ, Hambrick DC (2005) Conceptualizing executive hubris: the role of (hyper-) core self-evaluations in strategic decision-making. Strateg Manag J 26(4):297–319

    Article  Google Scholar 

  • Hirshleifer D, Low A, Teoh SH (2012) Are overconfident CEOs better innovators? J Finance 67(4):1457–1498

    Article  Google Scholar 

  • Huang R, Tan KJK, Faff R (2016) CEO overconfidence and corporate debt maturity. J Corp Finance 36:93–110

    Article  Google Scholar 

  • Huang-Meier W, Lambertides N, Steeley JM (2016) Motives for corporate cash holdings: the CEO optimism effect. Rev Quant Financ Acc 47(3):699–732

    Article  Google Scholar 

  • Jensen MC (1986) Agency costs of free cash flow, corporate finance, and takeovers. Am Econ Rev 76(2):323–329

    Google Scholar 

  • Jiang Z, Lie E (2016) Cash holding adjustments and managerial entrenchment. J Corp Finance 36:190–205

    Article  Google Scholar 

  • John TA (1993) Accounting measures of corporate liquidity, leverage, and costs of financial distress. Finan Manag 22(3):91–100

    Article  Google Scholar 

  • Kidd JB (1970) The utilization of subjective probabilities in production planning. Acta Physiol (Oxf) 34:338–347

    Google Scholar 

  • Kim CS, Mauer DC, Sherman AE (1998) The determinants of corporate liquidity: theory and evidence. J Financ Quant Anal 33(3):335–359

    Article  Google Scholar 

  • Lambert RA, Larcker DF, Verrecchia RE (1991) Portfolio considerations in valuing executive compensation. J Acc Res 29(1):129–149

    Article  Google Scholar 

  • Lemmon ML, Roberts MR, Zender JF (2008) Back to the beginning: persistence and the cross-section of corporate capital structure. J Finance 63(4):1575–1608

    Article  Google Scholar 

  • Malmendier U, Tate G (2005) CEO overconfidence and corporate investment. J Finance 60(6):2661–2700

    Article  Google Scholar 

  • Malmendier U, Tate G (2008) Who makes acquisitions? CEO overconfidence and the market’s reaction. J Financ Econ 89(1):20–43

    Article  Google Scholar 

  • Malmendier U, Tate G, Yan J (2011) Overconfidence and early-life experiences: the effect of managerial traits on corporate financial policies. J Finance 66(5):1687–1733

    Article  Google Scholar 

  • Miller DT, Ross M (1975) Self-serving biases in the attribution of causality: fact or fiction? Psychol Bull 82(2):213

    Article  Google Scholar 

  • Moore PG (1977) The manager’s struggles with uncertainty. J R Stat Soc Ser A (Gen) 140(2):129–148

    Article  Google Scholar 

  • Mukherjee S, Mahakud J (2010) Dynamic adjustment towards target capital structure: evidence from Indian companies. J Adv Manag Res 7(2):250–266

    Article  Google Scholar 

  • Opler T, Pinkowitz L, Stulz R, Williamson R (1999) The determinants and implications of corporate cash holdings. J Financ Econ 52(1):3–46

    Article  Google Scholar 

  • Orlova SV, Rao RP (2018) Cash holdings speed of adjustment. Int Rev Econ Finance 54:1–14

    Article  Google Scholar 

  • Öztekin Ö, Flannery MJ (2012) Institutional determinants of capital structure adjustment speeds. J Financ Econ 103(1):88–112

    Article  Google Scholar 

  • Roll R (1986) The hubris hypothesis of corporate takeovers. J Bus 59(2):197–216

    Article  Google Scholar 

  • Stotz O, von Nitzsch R (2005) The perception of control and the level of overconfidence: evidence from analyst earnings estimates and price targets. J Behav Finance 6(3):121–128

    Article  Google Scholar 

Download references

Funding

None.

Author information

Authors and Affiliations

  1. Strome College of Business, Old Dominion University, Norfolk, VA, 23529, USA

    Kenneth Yung

  2. Hollins University, Roanoke, VA, 24020, USA

    Xiang Long

Authors
  1. Kenneth Yung
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Xiang Long
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Kenneth Yung.

Ethics declarations

Conflict of interest

Kenneth Yung declares that he has no conflict of interest. Xiang Long declares that he has no conflict of interest.

Ethical approval

This article does not contain any studies with human participants performed by any of the authors.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix: Variable definitions

Appendix: Variable definitions

  • Cash/TA: Cash scaled by book value of total assets.

  • Cash/Sales: Cash scaled by sales revenue.

  • Firm size: Natural log of book value of total assets.

  • Tobin’s Q: (book value of assets-book value of equity + market value of equity) scaled by total assets.

  • Dividend dummy: Dividend (0,1) dummy is set to 1 if the company pays dividends.

  • Cashflow: EBITDA minus interest, taxes, and dividends, divided by total assets.

  • Capex/TA: Capital expenditures scaled by total assets.

  • Leverage: Long-term debt plus short-term debt divided by total assets.

  • MB: Market to book ratio computed as (liabilities + market value of equity) divided by total assets.

  • R&D/TA: R&D expenses divided by total assets.

  • CashDev: Deviation from target cash level.

  • LevDev: Deviation from target leverage.

  • Overconfidence dummy: A (0,1) dummy that is set to one if the CEO has unexercised options that are at least 67% in the money (Hirshleifer et al. 2012).

  • High-overconfidence CEOs: CEOs who hold unexercised options that are more than 250% in the money (Hirshleifer et al. 2012).

  • Medium-overconfidence CEOs: CEOs who hold unexercised options that are at least 130% but not more than 250% in the money (Hirshleifer et al. 2012).

  • Low-overconfidence CEOs: CEOs who hold unexercised options that are at least 67% but not more than 130% in the money (Hirshleifer et al. 2012).

  • ChangeOverconfidence: An indicator variable that has a value of +1 (-1) if CEO overconfidence increases (decreases) from the previous year. The value of ChangeOverconfidence is zero if there is no change in CEO overconfidence from the previous year.

  • ChangeOverconfidenceLevel: An indicator variable that reflects changes among high, medium, and low levels of CEO overconfidence between 2 years. Starting with a value of zero for non-confident CEOs, the value of ChangeOverconfidencelevel is increased (decreased) by one for each level of increase (decrease) in CEO overconfidence from the previous year.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Yung, K., Long, X. CEO overconfidence and the adjustment speed of leverage and cash: evidence on cash is not the same as negative debt. Empir Econ 63, 1081–1108 (2022). https://doi.org/10.1007/s00181-021-02158-5

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s00181-021-02158-5

Keywords

JEL Classification

Search

Navigation