Capital structure choice: the influence of sentiment in France

Abstract

The overconfidence bias in relation to investment decisions is well documented in psychology and behavioural finance literature. Less known is that an overconfidence bias also relates to financing decisions. Managers that are overconfident of their firm's future are likely to prefer debt to equity financing. This may lead to increased probability of bankruptcy and higher costs of capital. Empirically it is difficult to measure overconfidence. In this paper we decompose a publicly available measure of industry sentiment into two components: a component common with investor confidence and a component more aligned with manager industry confidence. We find in a sample of French firms that industry confidence and investor confidence are negatively related to leverage and that the unique component of manager industry confidence is positively related to leverage. This provides some support to the theory that overconfident managers prefer debt to equity. In the sample of French firms, the investor confidence component dominates, resulting in an overall negative effect of industry confidence with leverage. This may be due to higher levels of blockholder control and/or a weaker business environment in France relative to other countries.

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