Abstract
AbstractThis paper develops and empirically tests a new version of the trade‐off theory of corporate capital structure choices that accounts for CEOs' biased beliefs, with a focus on overcaution. We characterize the bias as a distortion of expected rates of return on equity and debt that, for Overcautious CEOs, are overestimated compared to a rational CEO. The theory shows that if CEOs have higher bias in equity, than in debt‐value estimation, overcautious CEOs will choose lower levels of debt compared to rational CEOs, and, if the degree of overcaution is sufficiently high, they will adopt a zero‐leverage policy.
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