Managerial Overconfidence, Investment-Cash Flow Sensitivity And Investment Efficiency

The overseas and domestic financial studies in the recent twenty years have both certified significant correlations between corporate investments and internal cash flows. When the capital expenditures of listed companies fluctuate greatly with different cash flow levels, it may be accompanied by over- or under-investment with surplus or inadequate cash flows, which harms the interests of shareholders and other related parties. Based on the rational person hypothesis, mainstream studies put forth investment theories such as the financial constraint hypothesis or the free cash flow hypothesis, and seek relevant governance measures. However, a great deal of psychological experiments has proved that overconfidence is prevelant among corporate managers. With this irrationality in decision-making, governance measures based on mainstream studies may fail to work. This paper tries to learn from and push forward the emerging behavioral financial research, and study managerial overconfidence of Chinese listed companies as well as its effect on investment-cash flow sensitivity and investment efficiency. The purpose is to provide clues for improving inefficient investment governance.The paper first gives up the asymmetric information hypothesis of the related study. By means of an investment decision model, it theoretically investigates the effect of managerial overconfidence on investment decisions under the conditions of financing adverse-selection and managerial moral hazard respectively. The analysis shows that for "good companies" represented by listed companies: (1) managerial overconfidence may result in over- or under-investment; (2) it is positively related to the companies' investment-cash flow sensitivity; all else equal, the more severe the financial constraint, the higher the above sensitivity; (3) taking both financing adverse-selection and managerial moral hazard into account, managerial overconfidence may have a non-monotonic effect on inefficient investment probabilities; (4) the degree of moral hazard of overconfident managers is unrelated to supervision, but is negatively affected by ownership incentives; overconfidence at a high level helps save corporate governance costs.The paper proceeds to empirically investigate how mangerial overconfidence affects investments and firm value of Chinese listed companies: (1) by measuring overconfidence based on Entrepreneur Confidence Index and management shareholding respectively, the paper shows that the majority of managers tend to be overconfident, and some of their personal characteristics and corporate governance features lead to difference in managerial confidence; (2) under the condition of financial constraint, 1) the overconfidence of management group composed of directors and executives has a more significant effect on corporate investments than that of CEOs or executives; 2) managerial overconfidence is significantly and positively related to corporate investment-cash flow sensitivity; 3).this effect is more evident when firms face serious financial constraint. The above findings hold even after controlling for asymmetric information problems or agency problem; (3) the effect of managerial overconfidence on investment efficiency (firm value) is explored by means of a simultaneous equation model, which shows that: 1) there is a significant interaction between managerial overconfidence and firm value via investment decisions; 2) firm value increase helps promote managerial confidence; 3) the effect of managerial confidence on firm value is non-monotonic, that is, the former up to a certain degree helps raise firm value (hence improve investment efficiency), but later on harms it.The study provides new policy implications for inefficient investment governance of listed companies: (1) the governance should not ignore decision-makers' cognitive bias; (2) it is helpful to reduce managers' inclination for overconfidence, stabilize cash flows, increase information disclosure or reduce financial constraint in order to prevent fluctuations in investments; (3) corporate governance should encourage and promote confident talents into the management team as well as timely intervene and adjust their self-confidence, so as to prevent it from being transformed into overconfidence; (4) supervision and incentive measures should be properly adapted to managers' confidence levels, and so on.