Managerial optimism: New observations on the unifying theory

Abstract

Managerial optimism theory is behavioral finance's greatest achievement. It explains two prominent features of corporate financial behavior – over‐investment and pecking‐order capital structure preferences – that otherwise require two different theories with mutually incompatible assumptions about managerial loyalties to shareholder‐value maximization. After reviewing the development of managerial optimism as a unifying theory, I use a simple change of measure to transform risk‐averse optimism to risk‐neutral probabilities that can be pessimistic or optimistic depending on wealth changes. This unexplored feature has implications for, among other things, pay for performance when managers are excessively optimistic.

Does managerial overconfidence affect capital structure rebalancing for entrepreneurial firms?

“…The significant differences found between the explanatory variables in the sample are consistent with the behavioural literature predictions (e.g. Malmendier and Tate, 2005b; Ben-JSBED 31,1 David et al, 2007;Li and Tang, 2010;Malmendier et al, 2011;Ben-David et al, 2013;Maditinos et al, 2016;Rihab and Lotfi, 2016;Pikulina et al, 2017;Koo and Yang, 2018;Malmendier, 2018;He et al, 2019;Bukalska, 2019;Heaton, 2019;Miglo and Brodziak, 2019;Bolton et al, 2020;Byoun, 2021;Ikeda et al, 2021). Firms run by OCM present higher average values of total debt, tangibility assets and non-debt tax shields.…”

“…, 2011; Adam et al. , 2015; Rihab and Lotfi, 2016; Miglo and Brodziak, 2019; Heaton, 2019; Kumar et al. , 2020; Miglo, 2020; among others).…”

“…The literature indicates that the manager's cognitive biases, particularly those related to overconfidence, have effects on financing choices and thus direct repercussions on the firm's capital structure (e.g. Lin et al, 2008;Malmendier and Tate, 2008;Park and Kim, 2009;Oliver, 2010;Oliver and Mefteh, 2010;Malmendier et al, 2011;Adam et al, 2015;Rihab and Lotfi, 2016;Miglo and Brodziak, 2019;Heaton, 2019;Kumar et al, 2020;Miglo, 2020;among others).…”

Can the Famous University Experience of Top Managers Improve Corporate Performance? Evidence from China

“…Even if managers were loyal to shareholders, they would still invest in the projects with negative net present value (NPV). A series of studies have indicated that overconfidence of top managers is highly correlated with corporate financial decision-making [24], such as investment and financing decisions [25][26][27], capital structure decisions [28,29], cash holding decisions [30], acquisition decisions [31][32][33] and dividend distribution decisions [34,35]. Overconfidence of top managers will influence corporate performance by affecting the choice of corporate financial strategy [36][37][38].…”

“…Hackbarth have pointed out that overconfident managers prefer higher debt levels, which are conducive to alleviating agency problems, restraining the "tunneling" behavior of management, and reducing conflicts between management and shareholders, thus increasing corporate value [28]. Nevertheless, based on agency cost theory and asymmetric information, Heaton proved that overconfidence of managers will damage corporate performance [24].…”