Supply‐side factors, CEO overconfidence, and zero‐leverage policy

Abstract

This paper investigates the effects of credit rating downgrades, equity mispricing, and CEO overconfidence on zero-leverage policy, using data for listed U.S. firms during the period 1980-2012. The results show that (a) the likelihood of zero leverage increases significantly following a downgrade in credit rating; (b) zero leverage is the outcome of the past attempts by firms to issue more overvalued equity capital; and (c) firms with overconfident CEOs are more likely to choose zero leverage. The results clearly suggest that the conditions prevailing in both credit and equity markets exert significant influence on zero-leverage policy. The analysis also advocates the inclusion of managerial biases in conjunction with the market-wide conditions in the analysis of zeroleverage policy. Overall, the findings reveal that zero-leverage firms find that the benefits of issuing overvalued equity outweigh the benefits associated with debt financing. These results are robust to a battery of checks.

Leverage, investment and institutional environments: Evidence from emerging markets

“…The dependent variable is Investment , calculated as net capital expenditures (capital expenditure minus depreciation) over total assets of firm i in year t . The independent variable of interest is Leverage calculated as total liabilities over total assets, following Ahn et al (2006) and Ebrahimi et al (2020). We include Growth measured by Tobin's Q (sum of market capitalization and total liabilities over total assets), following Chung and Pruitt (1994).…”

CEO overconfidence and debt covenant violations

“…Credit rating agencies often highlight the tone at the top as a vital element in their rating decisions (Hribar et al, 2013). Credit ratings have significant ramifications for bond yields, bank capital requirements, and the cost of capital (Ebrahimi et al, 2020;Roberts & Sufi, 2009). Prior studies (e.g., Malmendier & Tate, 2005;Malmendier et al, 2011) suggest that credit ratings are likely to be of particular importance to firms with overconfident CEOs because overconfident CEOs have a greater preference for either debt or internal funds over equity financing.…”

“…Third, we make vital contributions to understanding corporate governance policies and more precisely the role of boards in choosing, incentivizing, and monitoring CEOs. The tone at the top has significant ramifications for lenders and credit rating agencies (Ebrahimi et al, 2020;Hribar et al, 2013). Overconfident CEOs could mitigate the incidence of covenant violation, but only among loans to lower rated (non-investment-grade) borrowers and revolving lines of credit where benefits of effective monitoring are most pronounced.…”

Corporate Social Responsibility and Zero Leverage

“…Logit regression is the statistical fitting of an s-curve logit function to a dataset to calculate the probability of the occurrence of a specific categorical event based on the values of a set of independent variables. Logit regression is a predictive algorithm using independent variables to predict the dependent variable, specifically used in case of categorical dependent variable (Ebrahimi, 2020).…”