Managerial Overconfidence and Bank Loan Contracting
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I study the effect of managerial overconfidence on bank loan contracting. I find empirical evidence supporting that overconfidence as a personal trait of borrowing firm’s manager impacts loan contracting terms. Specifically, loans initiated between banks and firms with overconfident managers have significantly lower interest rates on average. However, I also find that overconfident managers are willing to accept a higher initial interest rate if the loan contract includes a performance pricing provision, and that the likelihood of including a performance pricing provision is greater for overconfident managers. These results are consistent with predictions that performance pricing provisions are a useful mechanism for alleviating the agency conflicts arising from managerial overconfidence. Furthermore, I find that managerial overconfidence is associated with higher covenant intensity, longer maturity, and larger loan amounts. For syndicated loans with overconfident managers, lead banks reduce their risk exposure by inviting more participant lenders, retaining lower shares of the loans, and reducing syndicate concentrations.