Why Do Overconfident REIT CEOs Issue More Debt? Mechanisms and Value Implications

Abstract

This paper examines why overconfident CEOs issue more debt than equity within US Real Estate Investment Trusts (REITs) and the value implications of this debt preference. Consistent with a demand-side story, the paper finds that overconfident CEOs choose to issue more debt than equity than their non-overconfident counterparts. The findings also rule out the supply-side story that overconfident CEOs are screened out of the equity market. CEO preference for debt is associated with a decline in shareholder wealth. Specifically, using an event study, the paper finds that overconfident CEOs suffer an approximately $67 million loss associated with debt issues in market capitalization. Further analysis suggests that the loss stems from the higher default risk induced by overconfident REIT CEOs’ debt preference. The demand-side explanation remains robust even after considering several CEO demographics, estimation methods, and the following five possible alternative drivers of the main results: (1) insider information; (2) risk tolerance; (3) past performance; (4) dividends; and (5) board pressure.