Survey evidence indicates that dilution and market timing are the top factors
that influence financial executives’ decisions about issuing new equity. The
top factor influencing financial executives’ decisions about new debt is financial
flexibility. As a group, financial executives also report that they attempt
to target values for their firms’ debt-to-equity
ratios. The behavioral APV approach to capital structure features errors and
biases by managers, the market, or both. Managers who perceive that the securities
of their firm are mispriced will be prone to engage in market timing. Such
activity will be tempered by the extent to which the firm is financially
constrained, its growth opportunities, and the sensitivity of its market price
to new issues or repurchases. Excessively optimistic, overconfident managers of cash-poor firms are prone
to reject positive NPV projects because they overvalue the equity of their
firms. Excessively optimistic, overconfident managers of cash-rich firms are
prone to adopt negative NPV projects because they overvalue the cashflows from
those projects. Two
indicators of CEO overconfidence involve press coverage and options exercise
behavior. The behavioral approach to capital structure suggests that
firms with excessively optimistic, overconfident managers feature investment
policies that exhibit excess sensitivity to cash flows. Empirical work shows
that firms with longholder CEOs have investment policies that are excessively
sensitive to cash flows. |