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Discussion of “The Role of Managerial Overconfidence in the Design of Debt Covenants”

Discussion of “The Role of Managerial Overconfidence in the Design of Debt Covenants”. Sudipta Basu. Is the paper interesting? . No accounting content Behavioral finance – but old theory… Managerial hubris... Roll (1986)

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Discussion of “The Role of Managerial Overconfidence in the Design of Debt Covenants”

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  1. Discussion of “The Role of Managerial Overconfidence in the Design of Debt Covenants” SudiptaBasu

  2. Is the paper interesting? No accounting content Behavioral finance – but old theory… Managerial hubris... Roll (1986) Still interesting to understand whether bondholders “pierce the corporate veil” (i.e. look through firm characteristics to managers actually making decisions)

  3. What’s the paper about? Are overconfident managers more restricted in their business activities? Do managers who do not rush stock option exercises have their judgment questioned by bondholders? Merger restrictions correlated with overconfidence, “abnormal” accruals, M/B, ROA, financing restrictions…

  4. Independent Dependent 1 Overconfidence X (X ) Distrust Y (Y) Conceptual 2 3 5 Option delay X Debt covenants Y Operational 4 Agency costs, Transparency, Profitability Vs (prior), Zs (current causes) Control Libby Boxes

  5. Validity threats related to Libby Boxes From easiest to hardest to think about: • Statistical Conclusion Validity (5) • Internal Validity (4) • Construct Validity (2 and 3) • External Validity (1 generalizes to ??)

  6. Are the results persuasive? Basic question is how well are potential validity threats addressed? Is a definitive/sharp test presented? Are multiple test results consistent? What is the totality of the evidence? Thin (regression) versus thick (case study, institutional detail) association

  7. Independent Dependent 1 Overconfidence X (X ) Distrust Y (Y) Conceptual Theory/External Validity Do we usually distrust overconfident people? How much is “optimal” confidence? How do we identify overconfidence? Can you be both depending on domain? Is overconfidence the same as optimism? Review PSYCHOLOGY research

  8. Independent Dependent 1 Overconfidence X (X ) Distrust Y (Y) Conceptual 2 3 Option delay X Debt covenants Y Operational Construct Validity (1) Negative Proxy Founder CEO? Family CEO? Very wealthy CEO? Power-hungry CEO Try Positive Proxies like N successive optimistic forecasts, MD&A or conference call tone, press or analyst descriptions…

  9. Independent Dependent 1 Overconfidence X (X ) Distrust Y (Y) Conceptual 2 3 Option delay X Debt covenants Y Operational Construct Validity (2) What are distrustful actions? Avoidance Recommend others Limited trial (credit line?) Boundaries (covenants) Compensation (interest) Model other distrustful actions —selection bias issues

  10. 2 3 5 Option delay X Debt covenants Y Operational 4 Agency costs, Transparency, Profitability Vs (prior), Zs (current causes) Control Internal Validity Easier to observe proxy for overconfidence? repeated optimistic management forecasts conference call behavior or MD& A tone WHO observes and decides?

  11. Other minor issues • Why don’t shareholders fire these CEOs? • Abnormal accruals = accounting ignorance • Conservatism reduces control denominators • Time-series clustering? (mid-1980s?) • Benchmark model with only control variables • Medians not means (very skewed variables) • Include predicted signs in tables

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