Information asymmetry may act as a catalyst for an association between managerial confidence and initial public offering (IPO) outcomes. This could occur if overconfident managers overinvest in producing information prior to going public, time offerings during periods when disagreement between managers and investors is low, or attempt to signal their beliefs to less informed market participants. Our evidence suggests that highly overconfident managers attempt to use underpricing to signal their beliefs to the market in an unsuccessful effort to receive greater value for their shares in follow-on offerings. This further suggests managerial overconfidence can be harmful to the firm.

We use firm and chief executive officer (CEO) characteristics motivated by optimal contracting theory to estimate optimal CEO relative debt-equity incentive ratios. Equity values rise as firms adjust CEO incentive ratios toward their predicted optimums, whether that increases or decreases the relative incentive ratio. Debt values rise as firms adjust ratios upward and do not fall as they adjust them downward. Our predicted optimums explain changes in equity and debt values better than a model in which firms simply match CEO inside debt-equity ratios to firm debt-equity ratios. The results suggest important cross-sectional differences in firms’ optimal inside debt policies.