Credit ratings and capital structure: New evidence from overconfident CFOs

Abstract

In this paper, we examine the impact of credit rating changes on the financing decisions of overconfident CFOs. We find that CFO overconfidence significantly increases the sensitivity of net debt issuances to the rating changes, particularly when firms have no access to low-risk debt. Specifically, we establish that speculative-grade firms with overconfident CFOs reduce net debt issuance following rating changes (i.e. upgrades and downgrades). Our results hold after controlling for CEO bias. Furthermore, we document that CEO overconfidence has explanatory power on firm financing policies as it generates the potential multiplier effect on debt conservatism, as well as on investment return. Findings of our paper are robust to model specifications and to the endogeneity bias.