What Drives Capital Structure Decisions?
The Role of Personality Traits in Corporate Financial
Decision Making
Nikolaos Daskalakis 1
Flora Kokkinaki
Athens University of Economics and Business
Nikolaos Kalogeras
Arvid Hoffmann
Elena Chrysikopoulou
Maastricht University
Extended Abstract
Recent research in finance has argued that the capital structure decisions and
firms’ funding and strategic choices deviate from the traditional neoclassical
paradigm (e.g., Shefrin, 2002; Baker and Nofsinger, 2010). This specific, nuanced,
research view has led scholars and practitioners to recognize that corporate
financial behavior (e.g., capital structure decisions, corporate behavior and
performance) also relies on different assumptions (e.g., irrational investors’
behavior, noise in securities’ trading activities, social and cultural influences on
investing behavior) from those that were supposed to be held according to the
traditional or standard finance paradigm. Baker et al., (2004), Vasiliou &
Daskalakis, (2009), Graham et al., (2009), among others, support that apart from
questioning the implications of the rationality principle regarding investors’
behavior as proposed by neoclassical financial theory, one may also account for
the irrational behavior of firm managers in order to make-up a more complete
irrationality approach and, hence a more well-grounded theoretical angle of
behavioral corporate finance. That is, modern finance theory acknowledges the
1
Corresponding author: Nikolaos Daskalakis, Athens University of Economics & Business,
Department of Marketing and Communication, e-mail: [email protected]
effects of behavior, that is, the human factor, on corporate financial decision
making.
Several recent studies have focused mainly on the effects of different
managerial traits on corporate investing behavior. For example, optimistic and
overconfident managers may predict a pecking order of financing decisions (Baker
et al., 2004), managers with growth perception bias overestimate the growth of
future earnings generated by their company and hence view external finance as
unduly costly (Hackbarth, 2007), CEOs that are more risk tolerant may initiate
more mergers and acquisitions projects (Graham et al., 2009), CEOs with
heterogeneous beliefs and opinions ascribed to their cognitive errors may deem
inconsistent corporate policies that tend to undervalue the company’s stocks in
the financial markets (Graham & Harvey, 2001), CEOs with depression
experience are averse to debt and lean excessively on internal finance, and CEOs
with military experience pursue more aggressive policies, including heightened
leverage (Malmendier et al., 2011). Despite the recognized importance of the
effects of these personality traits on corporate performance and behavior and
resulting financial policies, knowledge of the influence of a global, multi-facet,
personality dimension, which may provide a comprehensive and compelling rubric
for assessment and description of human (e.g., CEOs) personality, on behavioral
outcomes, and hence their impact on capital structure decisions, is limited. Most
research in finance has maintained a primarily analytical and descriptive focus and
studied the consequences of a priori heterogeneous CEO behavior for single
personality (e.g., risk-aversion) traits on corporate finance decisions. The lack of
empirical evidence, which can negatively affect the quality of decision-maker
choice and researcher understanding of corporate behavior and formation of
capital structure choices, is due in part to data constraints as well as difficulties in
determining the impact of a global, broad, personality dimension(s) of CEOs on
their capital structure decisions- which are not always directly observable—and in
accounting for their heterogeneous nature.
In this paper, we expand the literature by examining the impact of the five
broad dimensions/traits of CEOs personality - global personality dimensions - on
their capital structure decisions and identifying the heterogeneity in CEOs
underlying decision-making process. Specifically, we investigate the personality
traits of CEOs of publicly listed companies related to extraversion, agreeableness,
conscientiousness, emotional stability and openness to experience (Costa &
McCrae, 1992; Gosling, Rentfrow, & Swann Jr., 2003), as well as need for
cognition (Cacioppo, Petty, & Kao, 1984), self-esteem (Rosenberg, 1965), life
orientation – optimism (Scheier, Carver, & Bridges, 1994), intolerance to
ambiguity (Budner, 1962), sensation seeking (Hoyle et al., 2002; Zuckerman,
1994), risk tolerance (Grable & Lytton, 2003), and we examine their impact on
capital structure-related decisions. We select these multi-facet personality traits
because of their importance and relevance in explaining and predicting the actual
behaviour of individual decision-makers as argued by numerous scholars in
psychology (Mershon & Gorsuch, 1988; Goldberg, 1993; Paunonon & Ashton,
2001). We investigate the impact of latent heterogeneity on CEOs decisions, and
thus we divide them into distinct segments according to their personality traits.
That is, crucial knowledge may be revealed regarding differences in the underlying
decision making process of CEOs belonging in one segment (implying that they
posses similar personality traits) from CEOs belonging in other segment(s), that,
in turn, explains differences in their decisions related to capital structure issues
(i.e., deciding for the financing mixture; issuing new equity relatively often to
avoid obligations like debt; issuing of debenture for a new long-term investment).
To address our objectives, we use survey responses from CEOs that work for
publicly listed firms established and operating in Europe. So far 59 questionnaires
have been gathered and our survey is on an ongoing data collection level. Our
preliminary findings suggest that several personality traits composing the global
personality dimension of CEOs have a significant influence on certain capitalstructure related choices. Specifically: a) CEOs with high self esteem favor
decisions lowering the long-term liabilities-to-equity ratio and issuing new equity
that do not lead to financial obligations like debt; b) CEOs that are highly
extravert find exploiting possible advantages of each source of finance (i.e the
debt tax shield) more important than avoiding possible corresponding negative
consequences (i.e. debt financial distress). In contrast, CEOs who are intolerant to
ambiguity consider avoiding possible negative consequences more important than
exploiting possible advantages. Extraverted CEOs tend to issue new equity
whenever the debt-to-equity ratio is lower relative to the sector's ratio; c) CEOs
who are open to new experiences avoid traditional, available, funding sources.
They consider as more important the exploitation of possible advantages rather
than avoiding possible negative consequences and they tend to issue new equity
whenever the stock price is relatively high; d) The more conscientious a CEO is,
the more (s)he thinks that the stock market generally evaluates the firm at lower
levels than its real value; and finally, e) CEOs high in sensation seeking tend to
issue new equity, whenever the debt-to equity ratio is relatively high compared to
the sector's ratio while the more emotionally stable a manager is, the less (s)he
prefers issuing debenture. These results also lead us to conclude that personality
traits are closely related to specific value maximization impediments, viewed by
the behavioral finance perspective, such as aversion to ambiguity, illusion of
knowledge, anchoring and the availability heuristic.
Moreover, our results demonstrate interesting insights regarding several
combined rather than isolated effects on capital structure decisions. That is, the
decision for a certain financing mixture of publicly listed firm is driven by CEOs
consciousness, need for cognition and openness to experience. CEOs’ self esteem
and need for cognition drive their decisions to issue new equity relatively often.
Overall, these findings expand and confirm past research regarding the impact of
managerial traits on capital structure decisions. Analytical work is in progress for
constructing and examining the impact of a global personality index on certain
capital structure decisions as well as the identification of segments among CEOs
who posses similar personality traits. Knowledge of the impact of a global
personality profile on CEOs’ capital structure decisions may be useful to financial
policy makers to better evaluate efforts by CEO subgroups who may strive to
influence governance policies and investment strategies and hence, address the
importance of several agency-related problems. By acquiring such crucial
information, conflicting situations that undermine publicly listed firms’ success in
the financial markets may be prevented and continuous enhancement of
shareholders’ value may be achieved.
References
Baker, M., Ruback, R. & Wurgler, J. (2004). Behavioral Corporate Finance: A
Survey. NBER Working Paper, No. W10863.
Baker, H.K. & Nofsinger, J. (2010). Behavioral Finance, Investors, Corporations and
Markets. Kolb Series in Finance, Essential Perspectives. NJ: John Wiley & Sons.
Inc.
Budner, S. (1962). Intolerance of ambiguity as a personality variable. Journal of
Personality, 30, 29-50.
Cacioppo, J. T., Petty, R. E., & Kao, C. F. (1984). The efficient assessment of
need for cognition. Journal of Personality Assessment, 48, 306-307.
Costa, P. T., Jr., & McCrae, R. R. (1992). Revised NEO Personality Inventory (NEOPI-R) and NEO Five-Factor Inventory (NEO-FFI) professional manual. Odessa, FL:
Psychological Assessment Resources.
Goldberg, L. R. (1993). The Structure of Phenotypic Personality Traits. American
Psychologist, 48, 26–34.
Gosling, S. D., Rentfrow, P. J., & Swann, W. B., Jr. (2003). A very brief measure
of the Big-Five personality domains. Journal of Research in Personality, 37, 504-528.
Grable, J. & Lytton R. H. (1999). Financial risk tolerance revisited: the
development of a risk assessment instrument. Financial Services Review, 8, 163-181.
Graham, J., Harvey, C., & Puri, M. (2009). Managerial Attitudes and Corporate
Actions.
SSRN
Working
Paper.
Available
at
SSRN:
http://ssrn.com/abstract=1432641
Graham, J. R., & Harvey, C. R. (2001). The Theory and Practice of Corporate
Finance: Evidence from the Field. Journal of Financial Economics, 60, 187–243.
Hackbarth, D. (2007). Managerial Traits and Capital Structure Decisions. EFA
2004
Maastricht
Meetings
Paper.
Available
at
SSRN:
http://ssrn.com/abstract=362740 or doi:10.2139/ssrn.362740
Hoyle, R. H., Stephenson, M. T., Palmgreen, P., Pugzles Lorch, E., & Donohew,
R. L. (2002). Reliability and validity of a brief measure of sensation seeking. Personality and
Individual Differences, 32, 401-414.
Malmendier, U., Tate, A.G., & Yan, J. (2011). Overconfidence and Early-Life
Experiences: The Impact of Managerial Traits on Corporate Financial Policies.
Behavioral
&
Experimental
Finance
eJournal,
3(6):
available
at:
http://www.nber.org/papers/w15659
Mershon, B. & Gorsuch, R.L. (1988). Number of Factors in the Personality
Sphere: Does Increase in Factors Increase Predictability of Real-life Criteria?
Journal of Personality and Social Psychology, 55, 675–680.
Paunonen, S.V. & Ashton, M.S. (2001). Big five factors and facets and the
prediction of behavior. Journal of Personality and Social Psychology, 81, 524–539.
Rosenberg, M. (1965). Society and the Adolescent Self-Image. Princeton, NJ: Princeton
University Press.
Scheier, M. F., Carver, C. S., & Bridges, M. W. (1994). Distinguishing optimism
from neuroticism (and trait anxiety, self-mastery, and self-esteem): A reevaluation
of the Life Orientation Test. Journal of Personality and Social Psychology, 67, 10631078.
Shefrin, H. (2002). Beyond Greed and Fear: Understanding Behavioral Finance and the
Psychology of Investing. NY: Oxford University Press.
Vasiliou, D., & Daskalakis N. (2009). Behavioral capital structure: Is the
neoclassical paradigm threatened? Evidence from the field. Journal of Behavioral
Finance, 10, 19-32.
Zuckerman, M. (1994). Behavioral Expression and Biosocial Bases of Sensation Seeking.
New York: Cambridge University Press.