Short-Term Corporate Debt Linked To Overconfident CEOs

If CEOs drive businesses forward, the financial decisions they make — even if it’s deciding who will make those decisions for them — are critical. Researchers at the London School of Economics examined the role of the CEO in this light and uncovered connections regarding the behavior of acquiring debt.

According to researchers Ronghong Huang, Kelvin Jui Keng Tan and Robert Faff, CEO overconfidence is positively correlated with a preference for short-term debt products. The study looked to expand on past analysis of the connection between executives’ personal characteristics and the financial impact they have on corporations.

This time, however, the researchers looked at CEO overconfidence in particular to discover its connection to corporate financing policy.

In this instance, overconfidence includes an overestimation of their own abilities and skills, a consideration that their traits are above average. “For corporate executives, overconfidence means they generally overestimate future firm performance under their leadership,” the authors stated.

[bctt tweet=”‘For CEOs, overconfidence means they generally overestimate future firm performance.'”]

“In academic research, executive overconfidence has been shown to have substantial impact on corporate decision-making,” they continued. “For example, firms with overconfident CEOs are more likely to undertake value-destroying acquisitions, have higher leverage and engage in more share repurchases.”

The authors determined that overconfidence is also linked to a preference for short-term debt, arguing that these executives overestimate the ability of their firms to refinance that debt with lower costs as their business becomes more successful.

Analysis found that overconfidence increases average short-term corporate debt within a company; these executives also migrate towards newly contracted, short-term debt due within 12 months, the authors said.

“Our study helps further bridge the gap between behavioral finance and corporate financial decision-making and contributes to our understanding of corporate debt maturity at the individual decision-maker level, rather than the industry or firm levels, as focused by many of the prior studies,” the authors concluded.