Managerial Optimism and the Cost of Capital. The SEM-Approach with a Focus on the German Capital Market 

The present study contributes the first analysis of the influence of managerial optimism on companies’ financing policy and cost of capital. Since overconfidence biases investment and financing decisions, it may directly and indirectly influence a company’s risks and value. In contrast to prior research, which has almost exclusively been focused on the analysis of leverage, the present paper also takes risk measures into account to decompose the cost of capital and to identify direct and indirect effects of managerial optimism by using structural equation modeling (SEM). Based on a large sample of companies listed in Germany, this study found strong evidence that optimistic managers caused a higher equity risk and a higher risk of insolvency. However, this effect was not caused by the choice of leverage, and, thus, it must have been caused by investment-policy decisions. However, an optimistic management achieves a significant reduction in the overall cost of capital