Managerial Overconfidence, Moral Hazard Problems, And Excessive Life-Cycle Debt Sensitivity

This paper analyses the effects of managerial overconfidence on financing decisions and firm value when investors face managerial moral hazard. Authors consider two cases. In the first case, the manager may have an incentive to exert an inefficiently low level of effort in running the business. The manager may issue high debt as a commitment device. An overconfident manager overestimates his ability, and underestimates financial distress costs. Therefore, the first model predicts a positive relationship between overconfidence and debt. However, the effect of overconfidence on firm value is ambiguous, and depends which factor dominates.