V. Results
5.1 Firm valuation
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after pledge are positive to the profitability but excessive diffidence negative while that measured considered stock dividends are reverse consistent the results from statistics summary. Sales and R&D are positive correlated with Q, ROA and ROE and firm age are negative. Table 6 also reports the correlation of excessive overconfidence, excessive diffidence and stock performance and other related control variables.
Between the excessive overconfidence and excessive diffident, the total return is negative correlated with excessive overconfidence but positive with excessive diffidence no matter before or after pledge but excessive overconfidence and excessive diffidence are all negative correlated to total return after excluding stock dividends, moving to my prediction.
V. Results
In this section, I conduct regressions to examine the relationship between excessively overconfident CEOs /excessively diffident CEOs and firm profitability and stock performance.
5.1 Firm valuation
To understand the influence of CEO characteristic on firm value, I therefore examine the effect of confidence on future Tobin’s Q, Return on Assets, and Return on Equity (used by Hirshleifer, Low, and Teoh (2010), Fahlenbrach (2007)). Earlier study found that overconfidence increases R&D, which is expensed and therefore mechanically reduces the book value of assets in the short term. Since my three proxies contain assets and equities in the denominator, it is important to control for lagged related expenses in test with these dependent variables. Also factors would not affect firm profitability immediately thus all independent variables are lagged one
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period with respect to dependent variables. Considered there is differential effect from varies industries, three dependent variables are industry-adjusted to manifesting the idiosyncratic effect of CEOs.
Three regression specifications are defined as:
For test industry-adjusted Q I approximated by the ratio of the market value of assets to the book value of assets and then deduct industry’s median Q. The market value of assets is calculated as the sum of the book value of assets in the end of current fiscal year and the market value of common stocks that stock prices in the end of working day of current calendar year less the book value of common stocks and deferred taxes. The end of a fiscal year is similar to the end of working day of calendar year thus there is no deviation. The variable measuring the excessively overconfident CEOs (EO) (excessively diffident CEOs (ED)) is dummy variable that is one if the CEO of the firm is classified as excessive overconfidence (diffidence) and zero otherwise. To testify different influence of different excessive overconfidence (diffidence) level, I set top (bottom) 40%, 30%, 20%, and 10% end cutoffs on the distribution of Net Stock Purchases to examine the influencing trend of confidence level.
I show the results in Table 7 where I control the firm characteristic as the natural logarithm of sales and firm age (FA) and R&D scaled by book assets in the beginning of the year in column 1 to 4 and then control for the CEO characteristics as CEO share
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ownership (COW) and conduct year-fixed effect and industry-fixed effect in column 5 to 8. Panel A of Table 7 shows the regression results of Net Stock Purchases, Panel B of Net Stock Purchases after Pledge, Panel C of Net Stock Purchases excluding stock dividends, and Panel D of Net Stock Purchases excluding stock dividends after pledge.
As shown in Panel A and B, the coefficients of excessively overconfident CEOs are positive to negative large scale but non-monotonic: the effect of excessive overconfidence rebounds in top 20% cutoff and then goes deeply negative after controlling CEO characteristics. Nevertheless, after strictly measure CEO’s confidence by excluding stock dividends, the trend of excessively overconfident CEOs on Q conform to the expectation that the coefficients go down to deeply negative straight and significant at 1% level in panel C and D. For excessive diffidence, the coefficients are negative significantly at 1% but non-monotonic when approaching to the extreme cutoffs in Panel A and B and those migrates from positive to negative significantly at 10% in Panel C and D after considering the stock dividends.
The excessive overconfident and excessively diffident CEOs are adversely affected firms’ potential growth. The stricter measure of excessively overconfident CEOs measured by Net stock purchases excluding stock dividends after pledge tells the coefficients of top 10% is -0.1632 significant at 1%, which suggests that Q in excessively overconfident CEO firms is 113% less than in moderate overconfident CEO firms. The reasonable measure of excessive diffident CEOs measured by Net stock purchases tells the coefficient of bottom 10% is -0.0396 significant at 5%, which suggests that Q in excessively diffident CEO firms is 27% less than in moderate overconfident firms. Moreover, adverse effect on Q is bigger in excessively overconfident CEO firms than excessively diffident CEO firms.
For the second profitability measure industry-adjusted ROA, it is calculated as the ratio of earnings before interests, taxes, depreciation and amortization to book
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value of asset in the beginning of the year and then adjusted by deducting industry median ROA. All control variables are the same as above of Q and the results are shown in Table 8 with panel A to D. As same as the effect on Q, the coefficients of excessively overconfident CEO are negative to large scale and significantly at 1% but non-monotonic in panel A and B, but those are negative downward straight to large scale and significantly at 1% in panel C and D after considering stock dividends. Also the coefficients of excessively diffident CEO are all negative significantly at 1% but non-monotonic in panel A and B and those moves from positive to negative straight and significant at 5% in panel C and D.
As shown in Table 8, the excessive overconfident and excessively diffident CEOs are adversely affected firms’ ROA. The stricter measure of excessively overconfident CEOs measured by Net stock purchases excluding stock dividends after pledge tells the coefficient of top 10% is -0.0185 significant at 1%, which suggests that ROA in excessively overconfident CEO firms is 452% less than in moderate overconfident CEO firms. The reasonable measure of excessive diffident CEOs measured by Net stock purchases tells the coefficient of bottom 10% is -0.0067 significant at 1%, which suggests that ROA in excessively diffident CEO firms is 164% less than in moderate overconfident CEO firms. Same as Q that adverse effect on ROA is bigger in excessively overconfident CEO firms than excessively diffident CEO firms.
Third measure of firm profitability, industry-adjusted ROE, is defined as the ratio of earnings before interests, taxes, depreciation and amortization in the end of the year to the book value of equities in the beginning of the year and then adjusted by industry median ROE. The coefficients of excessively overconfident CEOs are negative monotonic to large scale significant at 1% in Panel B to D and those of excessively diffident CEOs are downward moving significant at 1% but
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non-monotonic same as the effect on industry-adjusted ROA.
From Table 9, the excessive overconfident and excessively diffident CEOs are adversely affected firms’ ROE. The stricter measure of excessively overconfident CEOs measured by Net stock purchases excluding stock dividends after pledge tells the coefficient of top 10% is -0.0312 significantly at 1% which suggests that ROE in excessively overconfident CEO firms is 148% less than in moderate overconfident CEO firms. The reasonable measure of excessive diffident CEOs measured by Net stock purchases tells the coefficient of bottom 10% is -0.01 significantly at 1%, which suggests that ROE in excessively diffident CEO firms is 47% less than in moderate overconfident CEO firms. Same as Q and ROA that adverse effect on ROE is bigger in excessively overconfident CEO firms than excessively diffident CEO firms.
From the above three measures of firm profitability, the excessively overconfident CEOs do harm the companies and the adverse effect enlarges when approaching the extreme cutoffs. Like Goel and Thakor (2008)’s prediction, drastic overconfident CEOs would overinvest in the projects no matter the positive or negative NPV by overestimate their ability and future firm value under their leadership. In the same way, excessive diffident CEOs also decrease firm profitability.
However, there is weaker effect of excessively diffident CEOs on firm performance, indicating that the underinvestment problem may not obvious or the results are positively biased for liquidity-motivated sales need.