The Effects of Capital Structure on Investment, Dividend, and Firm Value: Focusing on the Interactions with Management Overconfidence

This study demonstrates that the underinvestment problems due to a higher debt-equity ratio in corporate investment decisions can be mitigated by the overconfidence of managers. It can also mitigate the negative effect of a high debt ratio on cash dividends. The empirical results are as follows. First, we observe a decrease in capital expenditure and R&D investment, say "investment", and cash dividend with higher debt-asset ratios, resulting in significantly decreased firm values, consistent with existing literature. Second, however, higher management overconfidence results in lesser problems of underinvestment and passive dividend payout policy due to creditors’ influence. Third, even if the debt ratio is high, the level of the decrease in firm value is significantly reduced if management overconfidence is high. Fourth, however, the mitigating role of the management overconfidence is observed only in the firms belonging to highly competitive product markets, not the other way around. In short, higher management overconfidence can have a positive effect on corporate investment and firm value if product market competition imposes external discipline.