Discussion of �The Role of Managerial Overconfidence in the by F8bZ59

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									  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)

Still interesting to understand whether
   bondholders “pierce the corporate veil”
(i.e. look through firm characteristics to
   managers actually making decisions)
      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…
                Libby Boxes
                Independent                 Dependent

              Overconfidence     1         Distrust
Conceptual
                  X (X )                     Y (Y)
                    2                             3
              Option delay       5
Operational                             Debt covenants
                     X                        Y
                                                  4
Control        Agency costs, Transparency, Profitability
                    Vs (prior), Zs (current causes)
 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 ??)
    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
       Theory/External Validity
               Independent        Dependent

             Overconfidence   1   Distrust
Conceptual
                 X (X )            Y (Y)

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

What are distrustful actions?
             Overconfidence   1        Distrust
Conceptual
     Avoidance X (X )                   Y (Y)
     Recommend others
                   2                         3
     Limited trial (credit line?)
     Boundaries (covenants)
Operational   Option delay          Debt covenants
                   X
     Compensation (interest)             Y

Model other distrustful actions
    —selection bias issues
              Internal Validity
Easier to observe proxy for overconfidence?
  repeated optimistic management forecasts
  conference call 2behavior or MD& A tone
                                                  3
              Option delay       5
Operational                             Debt covenants
                   X                         Y
                                                  4
 Control       Agency costs, Transparency, Profitability
                    Vs (prior), Zs (current causes)

WHO observes and decides?
        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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