Restraining Overconfident CEOs Through Credit Ratings

Abstract

Overconfident CEOs significantly reduce their acquisition activity when facing a higher risk of a credit rating downgrade, possibly because credit ratings impact their ability to access external financing. Investment-grade firms managed by overconfident CEOs that are placed on a negative rating outlook reduce their acquisitiveness by approximately 16 percentage points. Our findings offer a novel perspective on the role of credit rating agencies as an external control mechanism, constraining overconfident managers from pursuing value-destroying acquisitions. Our findings survive a battery of robustness checks, including endogeneity, controlling for internal control mechanisms and market reaction tests.