Supply-Side Factors, CEO Overconfidence and Zero-Leverage Policy

International Journal of Finance and Economics, Forthcoming

35 Pages Posted: 23 Sep 2019

See all articles by Tahera Ebrahimi

Tahera Ebrahimi

Birmingham City University

Jairaj Gupta

University of Birmingham

Aydin Ozkan

University of Bradford - School of Management

Date Written: September 13, 2019

Abstract

This paper investigates the effects of credit rating downgrades, equity mispricing and CEO overconfidence on zero-leverage policy, using data for listed United States firms during the period 1980-2012. The results show that (1) the likelihood of zero-leverage increases significantly following a downgrade in credit rating; (2) zero-leverage is the outcome of the past attempts by firms to issue more overvalued equity capital; (3) firms with overconfident CEOs are more likely to choose zero-leverage. The results clearly suggest that the conditions prevailing in both credit and equity markets exert significant influence on zero-leverage policy. The analysis also advocates the inclusion of managerial biases in conjunction with the market-wide conditions in the analysis of zero-leverage policy. Overall, the findings reveal that zero-leverage firms find that the benefits of issuing overvalued equity outweigh the benefits associated with debt financing. These results are robust to a battery of checks.

Keywords: zero-leverage; credit rating; equity mispricing; CEO overconfidence

JEL Classification: G32, G34

Suggested Citation

Ebrahimi, Tahera and Gupta, Jairaj and Ozkan, Aydin, Supply-Side Factors, CEO Overconfidence and Zero-Leverage Policy (September 13, 2019). International Journal of Finance and Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3453500

Tahera Ebrahimi

Birmingham City University ( email )

The Parkside Building
5 Cardigan St
Birmingham, West Midlands B4 7BD
United Kingdom

Jairaj Gupta (Contact Author)

University of Birmingham ( email )

Edgbaston, Birmingham B15 2TT
United Kingdom
00-44-7795904913 (Phone)

Aydin Ozkan

University of Bradford - School of Management ( email )

Emm Lane
Bradford, West Yorkshire Bd9 4JL
United Kingdom

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