Capital Structure Decisions, Loss Aversion, and Equity Premium

Wolfgang Breuer, Ji Cao, Marc Oliver Rieger and K. Can Soypak

No 2019-04, Working Paper Series from University of Trier, Research Group Quantitative Finance and Risk Analysis

Abstract: Previous studies suggest that equity is sold at a premium in capitalmarkets and behavioral economists attribute this equity premium puz-zle to investors’ loss aversion. The market timing literature argues thatmarket evaluation of equity affects capital structure decisions of firms.Combining the two strands, we theoretically and empirically show thatinvestors’ loss aversion positively affects the leverage of firms. The ef-fect is robust to alternative regression approaches, definitions of lever-age, subperiods, and subsamples. The positive relation between lossaversion and leverage vanishes for firms with high bankruptcy risks,with high foreign holdings, or with high institutional holdings. Con-trolling for additional preferences and cultural variables does not sub-due the effect. Thus, unlike previous studies, we not only discusswhether mispricing of external financing instruments affects capitalstructure, but we elaborate on the reasons that generate mispricing inthe first place.

Keywords: Capital Structure; Loss Aversion; Equity Premium; Lever-age; Bankruptcy Risk (search for similar items in EconPapers)
JEL-codes: C61 G32 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2019
New Economics Papers: this item is included in nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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