Abstract
We develop a structural model to quantitatively analyze the effects of asymmetric beliefs and agency conflicts on capital structure. Capital structure reflects the dynamic tradeoff between the positive incentive effects of managerial optimism and the negative effects of risk-sharing costs. Consistent with empirical evidence, long-term debt declines with optimism, whereas short-term borrowing increases. Permanent and transitory risk components have contrasting effects. Long-term debt increases with the intrinsic risk, but varies nonmonotonically with the transient risk. Short-term borrowing declines with the intrinsic risk, but increases with the transient risk. Overall, our findings show that asymmetric beliefs significantly influence firms’ financial policies.
Highlights
There is growing evidence to suggest that managers and outside investors often have di¤ering beliefs about the pro...tabilities of projects in addition to asymmetric attitudes towards their risks (Malmendier and Tate, 2005 and 2008, Baker et al, 2007, Ben-David et al, 2007, Malmendier et al, 2009)
Our model incorporates internal imperfections arising from asymmetric beliefs and moral hazard as well as external imperfections arising from taxes and bankruptcy costs
We explore the e¤ects of managerial optimism 0, the transient risk 20, the intrinsic risk s2, and outside investors’initial mean assessment
Summary
There is growing evidence to suggest that managers and outside investors often have di¤ering beliefs about the pro...tabilities of projects in addition to asymmetric attitudes towards their risks (Malmendier and Tate, 2005 and 2008, Baker et al, 2007, Ben-David et al, 2007, Malmendier et al, 2009). (ii) Long-term debt and the manager’s inside equity stake decline with the transient risk of a ...rm’s earnings— the degree of uncertainty in agents’ priors about the pro...tability of a ...rm’s projects— while short-term debt increases. Our results are robust to an extension of the model in which the manager continues to service long-term debt interest payments even after the outside equity value falls to zero, that is, the ...rm e¤ectively becomes privately held. To provide further validation for the model, we calibrate its parameters to a sample of IPO ...rms for which uncertainty about future pro...tability and asymmetric beliefs are likely to be more important Consistent with this intuition, we ...nd that the degree of managerial optimism and the project’s transient risk are, much more quantitatively signi...cant relative to their calibrated values for the sample of general ...rms. Our results highlight the importance of imperfect information and asymmetric beliefs as determinants of capital structure, especially for entrepreneurial ...rms
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