Top management team optimism and its influence on firms' financing and investment decisions

• Date: 01 October 2020
• Author: Laura R. Rettig,Tobias Heizer
• Published date: 01 October 2020
• DOI: http://doi.org/10.1002/rfe.1092

Rev Financ Econ. 2020;38:601–622. wileyonlinelibrary.com/journal/rfe

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© 2020 University of New Orleans

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INTRODUCTION

Theory and evidence on the determinants of corporate financing and investment decisions are extensive and diverse. Apart

from firm-, industry-, and time-specific factors, research also discusses the role of managers. For instance, Bertrand and Schoar

(2003) identify general manager-specific effects in firm behavior. The idea is most intuitive for CEOs because they are the most

prominent and visible decision-makers within a firm. Accordingly, existing research focuses on the influence of CEO charac-

teristics on firm policies. However, CFOs and CIOs should also be expected to have an influence on cash, dividend, and capital

structure policies. Findings of studies which investigate the influence of managers in specific corporate positions on different

aspects of firm behavior do not fit into one big picture. For example, Bertrand and Schoar (2003) track managers across firms

over time and find that CFOs (and all “other”, unspecified officers) have more impact on financial decisions than CEOs. In

contrast, 36%–47% of CEOs consider themselves to be the dominant decision-maker for financial and investment decisions

compared to only 10%–24% of CFOs (Graham, Harvey, & Puri, 2015).

This paper casts doubt on the assumption that an individual manager alone, such as the CEO, is decisive for a firm's action.

We investigate the influence of managers’ optimism, which is defined as a generalized positive expectation about future events.1

Evidence shows that CEOs suffer from optimism and overconfidence and are more biased than the lay population (Graham,

Harvey, & Puri, 2013). Most studies in the literature focus on the CEO because they assume that CEOs are the dominant deci-

sion-makers. However, what happens if decisions are actually made within teams? Our results indicate that corporate financial

policies are driven by a collective attitude of the top management team (TMT). We find that if two or more members of the

Received: 29 November 2018

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Revised: 11 October 2019

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Accepted: 12 October 2019

DOI: 10.1002/rfe.1092

ORIGINAL ARTICLE

Top management team optimism and its influence on firms'

financing and investment decisions

TobiasHeizer1

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Laura R.Rettig2

1Munich School of Management, Institute

for Capital Markets and Corporate Finance,

Ludwig-Maximilians-Universität München,

München, Germany

2School of Business and Economics,

Finance Center Muenster, University of

Muenster, Münster, Germany

Correspondence

Laura R. Rettig, School of Business and

Economics, Finance Center Muenster,

University of Muenster, Münster, Germany.

Email: laurarettig@gmx.net

Abstract

This paper examines the influence of optimism among the top management team mem-

bers on corporate investment and financing decisions. We develop an optimism measure

based on voluntary insider transactions that is applicable to all officers and directors of a

firm. Our results suggest that corporate policies are not solely influenced by an individual

CEO's optimism, but rather driven by the attitudes of top management team members as

a group. In fact, we find that the impact of CEO optimism on corporate investment and

financing decisions depends on the optimism of other officers and/or directors. In con-

trast, if several other officers and/or directors, apart from the CEO, are optimistic, their

influence is significant, independent of CEO optimism. Our analyses include all public

US companies within the Compustat universe for a time span of 20years.

KEYWORDS

behavioral corporate finance, corporate capital structure, corporate investment, optimism, top

management teams

JEL CLASSIFICATION

G31; G32; G34; G14; G02

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HEIZER and RETTIG

TMT (other than the CEO) are optimistic, net debt issuance, investment cash-flow sensitivity and M&A activity increase.

Further, net equity issuance decreases. In many cases, the effect of TMT optimism trumps the effect of CEO optimism, but not

vice versa. This implies that corporate decisions are team decisions (Tulimieri & Banai, 2010). Thus, our results support ideas

in the strategic leadership literature that see top level managers as a team and interpret organizational outcomes as “reflections

of the values and cognitive bases of powerful actors in the organization” (Hambrick & Mason, 1984, p. 193).2

At the same time,

we cast doubt on the common perspective that the CEO is the most important and dominant decision-maker in a firm.

Our analyses require an optimism measure which is available for all TMT members. To the best of our knowledge, we are the first

to consider a management group optimism measure which takes into account the number of different managers who are identified as

optimistic within one firm. We assume that a person’s general tendency to be optimistic is inherent in character, but that the extent to

which optimism is expressed varies over time. Therefore, we implement a time-variant optimism measure (Sen & Tumarkin, 2015).

Our measure is based on managers’ voluntary net equity purchases of shares in their company and is therefore a time-variant modifi-

cation of the net buyer measure by Malmendier and Tate (2005). In contrast to existing optimism proxies based on option execution

behavior, our measure does neither require extensive and costly hand collection of data nor does it lead to a major restriction in

sample size.3

We implement this measure for all public U.S. companies within the Compustat universe for a time span of 20 years.

Similar measures based on Execucomp data are only available for significantly smaller firm and manager samples.

The remainder of this paper is organized as follows. Section 2 gives a literature review. In Section 3, we deduce our main

hypotheses. Section 4 provides details on the data and the sample construction. Section 5 presents our methodology including

the construction of our optimism measures. Section 6 presents descriptive analyses and Section 7 shows results from multivar-

iate regressions. Section 8 concludes.

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LITERATURE REVIEW

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The influence of managers on firm decisions

We will first discuss research on managerial influence on corporate decisions in general. Based on Bertrand and Schoar (2003),

who find that fixed effects of single top managers are important with respect to financial, investment, and organizational

strategies, many empirical studies analyze the influence of the CEO on firm policies in further detail. Cronqvist, Makhija, and

Yonker (2012) detect a positive connection between CEOs’ personal leverage and their firms’ leverage. Further, findings of

Graham et al. (2013), Yim (2013), Jenter and Lewellen (2015), and Cust´odio and Metzger (2013) suggest that CEOs’ risk

tolerance, age, career concerns, and experience influence the frequency and outcomes of mergers and acquisitions.4

However,

the existence of a significant CEO effect on firm behavior is controversial. Fee, Hadlock, and Pierce (2013) cannot identify any

changes in firm policies after exogenous CEO departures. Frank and Goyal (2007) also fail to find a strong influence of CEO

traits on corporate leverage and suggest that CEOs serve, at the utmost, as a proxy for the entire management team.

Research on the influence of TMT members apart from CEOs is less extensive. Bertrand and Schoar (2003) show that fixed

effects of the top five highest paid executives matter for several corporate policies. Further, Frank and Goyal (2007) detect an

influence of CFOs on corporate leverage which is at least as large as the one of CEOs. Empirical findings also suggest that traits

of directors influence firm decisions. The role of boards has changed over time from pure monitoring to a more active role that

includes the power to dismiss the top management.5

Therefore, the board of directors may also influence top management decisions. Accordingly, Güner, Malmendier and Tate

(2008) detect that commercial bankers joining boards raise external funding and diminish investment-cash flow sensitivities, whereas

investment bankers on boards lead to larger bond issues and less successful acquisitions. Moreover, Kolasinski and Li (2013) provide

evidence that strong and independent boards prevent overconfident CEOs from making bad acquisitions. Yet, strategic leadership lit-

erature calls for more research on the influence of executives beyond the CEO level (e.g., Finkelstein, Hambrick, & Cannella, 2009).

Only scarce empirical research goes even one step further and distinguishes between managerial positions and correspond-

ing responsibilities. Based on broad surveys, Graham et al. (2015) report that CEOs themselves claim to be the dominant

decision-makers in M&A decisions, whereas other investment decisions are a bit more likely to be delegated. CFOs state to be

dominant decision-makers for mostly capital structure decisions. Differentiating between CEOs, CFOs, and other executives,

Bertrand and Schoar (2003) find that CFO traits matter more for financial decisions. Accordingly, Six, Normann, Stock, and

Schiereck (2013) find that CEOs rather influence firm performance and transactional policies compared to CFOs who shape

funding policies. Further, Malmendier, Tate, and Yan (2011) refer to anecdotal evidence that CFOs may design financing de-

cisions, but the CEO alone still needs to approve the respective sanctions and may overrule the CFO. Similarly, Cust´odio and

Metzger (2013) provide evidence that CEOs influence financial policies by changing the CFO.