Managerial Overconfidence and Speed of Leverage Adjustment

Based on the traditional trade-off theory, companies have an optimal leverage ratio that maximizes firm value. Therefore, whenever a deviation exists, companies will try to adjust their real leverage toward the optimal level (target leverage). Several factors could impact the speed of adjustment. In this study, the effect of managerial overconfidence on the speed of leverage adjustment has been investigated and the intensity of this effect has been compared among over-leveraged and under-leveraged firms. For this purpose, we use data from 179 firms listed on Tehran Stock Exchange during 2002-2021. We used the generalized method of moments (GMM) approach with controlled years and industries effects. The results indicate that managerial overconfidence reduces the speed of adjustment of market leverage. Moreover, in over-leveraged firms, the negative effect of managerial overconfidence on the speed of adjustment is less severe compared to other firms. The results of robustness tests, in which an alternative proxy was used for managerial overconfidence, are consistent with the main findings of the study. The research findings are consistent with the theoretical framework.