The impact of management confidence on capital structure

Abstract

This paper represents one of the first studies to document the empirical relation between capital structure and management confidence. In a unique sample of US firms that have existed for over 25 years we find management confidence, as proxied by University of Michigan Consumer Sentiment Index, is highly significant in explaining firm financing decisions. When management confidence is higher firms have higher levels of debt. This result is robust to different definitions of leverage and confidence as well as different model specifications. This confirms the theoretical arguments in behavioural finance that overconfident managers will tend to issue more debt. Market-to-book is found to be a significant determinant of capital structure as documented by previous studies. It is likely that this is due to market timing rather than growth opportunities as the sample of firms used in this study are not expected to be growth firms. In addition, this study provides additional evidence that timing of equity issues is not persistent as documented by Baker and Wurgler (2002). The lack of significance in persistence of timing of equity issues in the sample of firms indirectly supports the results of Hovakimian (2005), that the measure is a proxy for growth opportunities.