Academic journal article Researchers World

CEO Emotional Bias and Capital Structure Choice Bayesian Network Method

Academic journal article Researchers World

CEO Emotional Bias and Capital Structure Choice Bayesian Network Method

Article excerpt


This research examines the determinants of firms' capital structure introducing a behavioral perspective that has received little attention in corporate finance literature. The following central hypothesis emerges from a set of recently developed theories: firms managed by loss aversion, optimistic and/or overconfident people will choose more levered financing structures than others, ceteris paribus. The article explains that the main cause of capital structure choice is CEO emotional bias (optimism, loss aversion and overconfidence). I will use Bayesian network method to examine this relation. Emotional bias has been measured by means of a questionnaire comprising several items. As for the selected sample, it has been composed of some 100 Tunisian executives. Our results have revealed that the behavioral analysis of financing options implies the presence of peking order choice (Peking Order Theory, POT). CEO (optimistic, loss aversion, and overconfidence) prefer to finance their projects primarily through internal capital, by debt in the second hand and finally by equity.

Keywords: emotional bias; corporate finance; optimism; overconfidence; loss aversion; capital structure choice; Bayesian network.

Jel Classification: D2, G3, L2, L5, M1

(ProQuest: ... denotes formulae omitted.)


Studies focusing the determinants of firms' financing decisions address the problem from a wide range of perspectives. In many cases, the distinct theoretical approaches are complementary. For instance, the tax benefits of debt and the potential effects of greater financial leverage in mitigating conflicts of interest among outside shareholders and managers in a given firm could be simultaneously weighted in a decision concerning its ideal capital structure. Nonetheless, some of the determinants suggested in this literature are likely to be more relevant than others for explaining observed financing patterns. This empirical question has motivated an increasing number of studies about the actual drivers of firms' capital structure.

Static Trade-off Theory ( STT) and Pecking Order Theory (POT) is the body of theory of reference that addressed the issue of the financial structure of the firm. The first (STT) is based on a trade-off between costs (bankruptcy costs explicit or implicit, agency costs of debt related to conflicts of interest between bondholders and shareholders...) and earnings (shields deriving from the deductibility of interest payments) associated with the debt to obtain an optimal financial structure to maximize the value of the firm (Ross,1977 ; Jalilvand and Harris, 1984 ; Myers, 1984; Titman and Wessels, 1998; Stulz ,1990 ; Graham ,2000 ; Booth and al , 2001;-). As against the second ignores the concept of optimal financial structure and argues that the choice of financing is through a hierarchical order. This approach sustains that companies will tend to follow a hierarchy of preference for alternative financing sources motivated by the informational asymmetries between their managers and outside investors. Specifically, because firms will tend to seek financing sources that are less subject to the costs of informational asymmetries, they will prefer to fund their business with internally generated resources. They will only turn to external sources when necessary, preferably contracting bank loans or issuing debt securities (Myers, 1984 ; Myers and Majluf, 1984; Graham and Hervey, 2001; Fama and French, 2002; Frank and Goyal, 2007; Bushman and al, 2004; Antoniou and al, 2007; Huang and Ritter, 2009;..)

All of the above mentioned approaches hold in common one important point, namely, the implicit assumption that financial market participants as well as company managers always act rationally. However, an extensive and growing literature on human psychology and behavior shows that most people, including investors and managers, are subject to important limits in their cognitive processes and tend to develop behavioral biases that can significantly influence their decisions. …

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