CEO traits, dynamic compensation and capital structure

Area of Science:

• Corporate Finance
• Behavioral Economics
• Management Science

Background:

• Managerial traits significantly influence corporate financial decisions.
• Understanding the interplay between psychological factors and capital structure is crucial for financial theory.
• Existing models often assume rational decision-making, neglecting behavioral influences.

Purpose of the Study:

• To investigate the impact of managerial optimism, confidence, and risk aversion on a firm's capital structure.
• To analyze how these traits affect managerial effort within a principle-agent framework.
• To determine if specific levels of risk aversion can mitigate the influence of optimism and confidence on leverage.

Main Methods:

• Utilizing a principle-agent framework to model managerial decision-making.
• Analyzing the theoretical implications of varying managerial traits on capital structure choices.
• Comparing the effort levels of optimistic/confident managers versus rational managers.

Main Results:

• Optimistic managers favor equity, while confident managers prefer debt due to perceived undervaluation.
• A specific threshold of risk aversion can eliminate the impact of optimism and confidence on leverage.
• Optimistic and confident managers exert higher effort than rational managers, with effort decreasing as risk aversion increases.

Conclusions:

• Managerial psychological traits are significant determinants of capital structure.
• The principle-agent model effectively captures the influence of behavioral biases on financial decisions.
• Findings provide theoretical support for empirical observations in corporate finance.