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

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Abstract

This paper investigates the effects of credit rating downgrades, equity mispricing and CEO overconfidence on zero-leverage policy, using data for listed United States firms during the period 1980-2012. The results show that (1) the likelihood of zero-leverage increases significantly following a downgrade in credit rating; (2) zero-leverage is the outcome of the past attempts by firms to issue more overvalued equity capital; (3) 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 zero-leverage 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.
LanguageEnglish
JournalInternational Journal of Finance and Economics
Publication statusAccepted/In press - 13 Sep 2019

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Chief executive officer
Supply side
Overconfidence
Leverage
Factors
Equity
Credit rating
Debt financing
Mispricing
Inclusion
Credit markets
Equity capital
Equity markets

Cite this

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title = "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 United States firms during the period 1980-2012. The results show that (1) the likelihood of zero-leverage increases significantly following a downgrade in credit rating; (2) zero-leverage is the outcome of the past attempts by firms to issue more overvalued equity capital; (3) 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 zero-leverage 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.",
keywords = "Zero-leverage, credit rating, equity mispricing, CEO overconfidence",
author = "Tahera Ebrahimi and Jairaj Gupta and Aydin Ozkan",
year = "2019",
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language = "English",
journal = "International Journal of Finance and Economics",
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AB - This paper investigates the effects of credit rating downgrades, equity mispricing and CEO overconfidence on zero-leverage policy, using data for listed United States firms during the period 1980-2012. The results show that (1) the likelihood of zero-leverage increases significantly following a downgrade in credit rating; (2) zero-leverage is the outcome of the past attempts by firms to issue more overvalued equity capital; (3) 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 zero-leverage 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.

KW - Zero-leverage

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KW - equity mispricing

KW - CEO overconfidence

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