International Journal of Innovation, Creativity and Change. www.ijicc.

net
Volume 13, Issue 8, 2020

Relationship between Managerial

Overconfidence and Firm Value
Ghanny Trianitaa, Basukib*, a,bDepartment of Accountancy, Faculty of
Economics and Business, Universitas Airlangga, Email:
b*
basuki@feb.unair.ac.id

This study aims to examine the relationship between managerial

overconfidence and firm value. The study was conducted on
manufacturing firms listed on the Indonesia Stock Exchange from
2014 to 2016, with a total of 381 firm-year observations from 136
different firms. Managerial overconfidence in this study is measured
through two proxies, namely over-investment and capital expenditure,
while the firm value is measured using the Tobin's Q ratio. The
analytical method used is the OLS regression analysis using SPSS
version 20. The results of this study indicate that managerial
overconfidence, both measured through proxy investment and capital
expenditure, has a positive relationship to firm value. This research
shows that managerial overconfidence does not always have a negative
connotation and needs to be taken into consideration in managing a
firm.

Key words: Managerial overconfidence, overinvestment, capital expenditure, firm

value.

Introduction

The main long term objective of a firm established is to increase the prosperity of the owner
or shareholder by maximising the value of the firm. By doing so, the firm value becomes a
reflection of the success of the firm's performance that will have an impact on investor
perceptions of the firm (Harymawan et al., 2019). Investors will conduct several analyses and
considerations to decide which firm's shares are considered the most enticing to buy. The
analysis is often based on two approaches, namely, technical analysis and fundamental
analysis (Sutrisno, 2012). The focus in this research is the fundamental analysis which
focuses on the consideration of the issuing firm performance that can be assessed through the
study of financial ratios that help measure the success of the firm as well as evaluating the
merits of economic decisions taken, including investment decisions, funding, and dividend

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policies (Irawati et al., 2019; Iswajuni et al., 2018). As these decisions determine the
prosperity of shareholders, the accuracy of managers in making decisions is a major
consideration for investors as a belief that the funds invested will be managed appropriately
(Zulaikah et al., 2019; Nowland, 2012).

Managers often face uncertainties in practice that lead to complicated estimates. Thus, it is
probable that managers make mistakes, both underestimate and overestimate. Weinstein
(1980) found that managers as decision-makers tend to get out of rationality and often display
cognitive biases, one of which is overconfidence bias. Overconfidence begins with
psychological literature related to the "better than average" effect, where a person tends to
overestimate the knowledge, abilities, and accuracy of the information he has (Bhandari &
Deaves, 2006). Overconfidence can describe two phenomena in the decision making process;
(1) a tendency to express excessive belief in individual capacities and (2) overestimation of
the accuracy of knowledge that causes managers to be overly optimistic about favorable
outcomes (Bazerman & Moore, 2009). Different levels of overconfidence at different levels
of management. The higher one's position in management, the higher the level of
overconfidence in decision making (Paluch, 2011). The existence of overconfidence bias will
have an impact on managerial actions and strategic policies taken, especially in terms of
investment, mergers, and acquisitions, firm expansion, to funding decisions (Hirshleifer et al.,
2012; Malmendier & Tate, 2005).

The impact of the overconfidence bias on managerial actions can be seen from two different
perspectives. Graham et al. (2010) and Hirshleifer et al. (2012) found that managerial
overconfidence has a positive impact as overconfident managers are considered more
effective in exploiting growth opportunities and translating them into firm value. This
increased firm value is because overconfident managers tend to dare to take risks and invest
more in research and development activities that produce innovation (Munizu & Hamid,
2018). In contrast, Fallah et al. (2010) precisely show a negative impact because managers
who overconfident exaggerate their knowledge and skills, underestimate risk, and consider
themselves able to control every event and problem when, in fact, not the case. This
excessive optimism encourages managers to overestimate the benefits to be gained from an
investment project and underestimate the risk of the project. Thus, overconfident managers
continue to take on projects that generate negative NPVs (Zhang & Yang, 2018). Kim et al.
(2016) also show that overconfident managers tend to be more aggressive in investing and
often misinterpret negative NPV as a process of value creation and ignore negative feedback
because they have high confidence that the project possesses a promising future.

Prior studies that examine the relationship between managerial overconfidence and firm
value are still minimal, but include Dashtbayaz and Mohammadi (2016), who state that
managerial overconfidence has a negative relationship on firm value. Hirshleifer et al. (2012)

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say that managerial overconfidence has a positive relationship on growth opportunities that
are translated into firm value. Therefore, this study aims to analyze the relationship between
managerial overconfidence and firm value. This study uses all manufacturing firms listed on
the Indonesia Stock Exchange from 2014 to 2016, with a total final sample is 381 firm-year
observations. The manufacturing industry was chosen because it is one of the leading
business areas that dominate the structure of the Indonesian economy according to the
Central Statistics Agency information in the Indonesian economic report published by Bank
Indonesia (2018). Based on that report, the manufacturing industry has a significant
contribution to Indonesia's Gross Domestic Product, amounting to 21.08% in the year 2014;
20.99% in 2015; and 20.52% in 2016, which makes the manufacturing sector have the
potential to grow and make more investments. The analytical method used is the OLS
regression analysis using SPSS version 20 application.

The results of this study indicate that managerial overconfidence, as measured by

overinvestment measures and capital expenditure, has a positive relationship to firm value.
This relationship suggests that overconfident managers are more willing to take risks and are
considered more effective in exploiting growth opportunities and translating them into firm
value. This research contributes to the literature by illustrating that managerial
overconfidence can be one indicator in assessing the value of a firm. In this study, managerial
overconfidence can be considered in managing a firm, because it can increase the value of the
firm from the perspectives of investors. This consideration is because in assessing the
performance of firm management, investors also see the existence of managerial
overconfidence, not only from aspects that can be measured using a monetary parameter.

The research will be explained in the following structure: Section 2 contains research on
developing research hypotheses; Section 3 includes explanations for variables and samples as
well as research models; Section 4 contains empirical analysis and the results of hypothesis
testing; and Section 5 provides conclusions or conclusions from the study, including
suggestions for further research.

Literature Review
Theoretical Framework

Signalling theory discusses firms giving signals to users of financial statements. The signal
provided can contain information about what management has done in the framework of
realising the prosperity of the shareholder (Akerlof, 1970). Next, Spence (1973) describes the
signal given by the owner of the information provided an essential piece of information for
the recipient. Then, the recipient will adjust his behaviour based on his understanding of the
signal.

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The primary assumption of this theory is to provide space for shareholders to find out
information of to what extent the accuracy of decisions taken by management is related to
firm value. When management acts opportunistically, management faced with conditions of
uncertainty can be overconfident in making decisions, for example, in terms of investment,
resulting in over-investment that is motivated by certain motives such as incentives
(Malmendier & Tate, 2005). Instead, management can choose to avoid risk (risk-averse) by
only taking low-risk investments because of the uncertainty of cash flow and personal factors
such as effort, expertise, and knowledge to increase shareholder value (Baird et al., 2008;
Lumbanraja et al., 2018; Sari et al., 2018). This behaviour is done to ensure their position in
the firm. The two conditions above are based on the manager's decision, which is not
appropriate and will become an unfavourable signal for investors in the capital market
because it does not bring maximum utility, as well as affect investors' valuation of the firm,
which then impacts on firm value.

In a standard economic or financial perspective, humans are assumed to always act rationally,
including managers in carrying out economic activities, one of which is decision making. But
from a psychological point of view, this is not the case. Humans, as economic agents, tend to
show behaviours that are not entirely rational and display cognitive biases. Therefore,
behavioural finance is present and tries to learn how humans behave in a financial
determination (Nofsinger, 2001), assuming that humans are "normal" and under the influence
of sentiment and bias. Some literature from behavioural finance considers bias as a
systematic deviation from norms, or tendencies toward certain dispositions or conclusions
(Sahi & Arora, 2012; Wolman, 1973). Shefrin (2000) groups these biases into two broad
groups, namely frame-dependent bias and heuristic driven bias.

Frame dependent bias is the tendency that a person's response to a situation depends on how
the case is framed or presented, not on the facts of the situation. This bias is often attached to
investors in making investment decisions. While heuristic driven bias is the tendency for
someone to make decisions quickly based on "trial and error" and the experience they have
(rule of thumb) to process information which is then used in making decisions (Tversky &
Kahneman, 1974). From the two groups of biases, there is a heuristic driven bias that is often
experienced by managers as decision-makers, namely the overconfidence bias examined in
this study.

Overconfidence begins with the psychological literature "better than average effect" which
states that a person tends to judge himself as having knowledge and abilities above the
average of others, as well as "illusion of control" where the individual believes that he has
control over uncertain events and did not have fully responsible for random or uncontrolled
events (Larwood & Whittaker, 1977). This bias encourages overconfidence managers to
overexpose themselves to the idiosyncratic risk of the firm and is too optimistic in predicting

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future earnings (Hribar & Yang, 2016; Lobao, 2016). This perception of control and
optimism within the manager can be motivated by the desire for reputation, power, or
personal wealth that depends on the decisions made (Heaton, 2002; Herlambang & Nasih,
2019).

Roll (1986) researches the relationship between managerial overconfidence to financial

issues. The study states that managerial overconfidence encourages managers to make
estimates that are too optimistic or too high on investment returns to be obtained in the future,
and underestimates the risks of these investments. Managers who are overconfident will
choose to acquire another firm after the first acquisition is considered successful, even though
the subsequent acquisition is deemed to be risky (Meikle et al., 2016). Other literature also
links managerial overconfidence to investment, where firms with overconfident managers
have above-average capital expenditure levels and overinvest incorporate assets and
innovative activities (Ben-david et al., 2013; Engelen et al., 2015; Hirshleifer et al., 2012;
Malmendier & Tate, 2005). The optimal investment decision is crucial as a determinant of
firm value (Fama, 1978; Hidayat, 2010). Firm wealth or value can be increased if the decision
has maximised NPV after taking into account the time value of money (Husnan &
Pudjiastuti, 2002).

Relationship between Managerial Overconfidence Based On Overinvestment to Firm

Value

Agency theory provides a concept of how the relationship between agent and principal and
how the relationship can lead to agency problems that encourage managers as agents to act on
their interests and put aside the interests of shareholders as principals (Jensen, 1986). The
primary purpose of the establishment of a firm is to maximise the prosperity of shareholders
through the firm value that can be achieved through financial decisions made appropriately,
such as investment decisions. However, in practice, the presence of cognitive bias in a
manager makes the decision taken to be inappropriate, and this affects the perspective of
investors or shareholders towards the firm which then becomes a signal for taking action on
the capital market which ultimately affects the firm's value (Elmanizar et al., 2019).

Some previous literature explains that one of the biases that are often experienced by
managers as decision-makers is overconfidence bias, which is then known as managerial
overconfidence (Heaton, 2002; Malmendier & Tate, 2008). Overconfidence makes managers
believe that they have abilities above average so that they tend to overestimate benefits to be
gained in the future. Heaton (2002) and Malmendier and Tate (2008) find that managerial
overconfidence bias is the cause of investment irregularities and the overestimation of return
on investment projects. Thus, investment projects taken tend to exceed the ability or the level
of growth of the firm itself. Hirshleifer et al. (2012) and Malmendier and Tate (2005) also

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state that overconfident managers often overinvest both investments in firm assets and
innovative activities.

In the capital market, the presence of overconfident CEO becomes a signal for investors. It
then makes the market react by releasing ownership shares in the firm concerned to anticipate
the possibility of adverse actions that could potentially be taken by overconfident CEO in the
future (Yilmaz & Mazzeo, 2014). This reaction is in line with Dashtbayaz and Mohammadi
(2016) and Shah et al. (2018), who explain that the existence of managerial overconfidence
has a negative relationship on firm value. Based on this explanation, the hypothesis proposed
in this study are as follows:

H1: Managerial overconfidence based on overinvestment has positive relationship to firm

value.

Relationship between Managerial Overconfidence based on Capital Expenditure to Firm

Value

Capital expenditure or investment expenditure for capital goods such as factories, machinery,
equipment, and other tangible assets is needed by the firm in carrying out operating activities
to keep production cycle running. Thus, these expenditures require planning and control
because they involve long-term commitments. The manager, as the decision-maker, must
make careful calculations both in the amount and time of the implementation of these
expenditures. The use of capital expenditure as an investment decision provides a positive
signal for investors because it has the potential to bring increased performance with the
increase in the capital it has and is expected to generate profits in the future. However, the
existence of managerial overconfidence encourages managers to often make capital
expenditures above the average of other similar firms (Ben-David et al., 2013). Thus, capital
expenditure can affect the way investors perceive the firm performance. This effect is then
reflected through the firm's firm value. Therefore, the hypothesis proposed in this study is:

H2: Managerial overconfidence based on capital expenditure has positive relationship to firm
value.

Research Methodology
Sample and Data Source

Sources of data in this study were obtained through firm financial reports obtained either
from the official website of the Indonesia Stock Exchange (IDX) or the official website of
each firm. The sample used in this study were all manufacturing firms listed on the Indonesia
Stock Exchange (IDX) for the 2014-2016 period, which amounted to 381 firm-year

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observations. Manufacturing firms consist of several sectors, namely the elemental and
chemical industry sector, various industrial sectors, and the consumer goods industry sector.
Samples are selected using a purposive sampling method where sampling is done with
specific considerations and limitations. Table 1 shows the sample selection criteria used in
this study.

Table 1: Sample Selection Criteria

Year
Description 2014 2015 2016 Total
Listed manufacturing firms in IDX for period 2014-2016 143 143 144 430
Firms that their fiscal year end not at December 31 (3) (3) (3) (9)
Missing data (13) (13) (14) (40)
Final Sample 127 127 127 381

Variable Operationalisation
Dependent Variable

The dependent variable in this study is a firm value (FVALUE). In this study, firm value is
measured using Tobin's Q because it can show current market estimates of the return of every
Rupiah of incremental investment. If Tobin's Q is above one, this provides information that
investing in assets generates profits that give a higher value than the investment expenditure.
Tobin's Q value to find out the firm value is calculated using the following formula:

FVALUE = 𝐸𝐸𝐸𝐸𝐸𝐸+𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷
𝑇𝑇𝑇𝑇

Where EMV is the market value of equity obtained by multiplying the closing price with the
number of ordinary shares outstanding, DEBT is the book value of total debt, and TA is the
book value of total assets.

Independent Variable

The independent variable used in this study is managerial overconfidence. In measuring

managerial overconfidence, this study uses a proxy that refers to previous research
(Dashtbayaz & Mohammadi, 2016; Duellman et al., 2015; Shah et al., 2018), namely
overinvestment (OVERINVESTMENT) and capital expenditure (CAPEX). Overinvestment
is a condition where the investment expenditure of firms in various projects has exceeded
their capacity and finances (Hosmand & Khanaga, 2014). Overinvestment can occur when
managers have then used the firm's free cash flow to invest in investment projects that have
to sacrifice the firm's profitability or harm the interests of shareholders (Jensen, 1986).
Overinvestment is based on the deviation from the expected investment. In measuring
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overinvestment, the first step is to estimate the firm's investment model as a function of firm
growth measured through sales growth as used (Biddle et al., 2009). Next, to measure
whether the firm is overinvesting, which is then used by Duellman (2015) in his research as a
proxy for managerial overconfidence as follows:

Investmenti,t+1 = β0 + β1*Sales Growthi,t + εi,t+1

Where, Investmentt+1 is obtained from formula as follows:

Investmentt+1 = 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑡𝑡+1 + 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅ℎ & 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑡𝑡+1

+ (𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜 𝑃𝑃𝑃𝑃𝑃𝑃−𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑃𝑃𝑃𝑃𝑃𝑃) 𝑡𝑡+1
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑡𝑡

Next, Sales Growtht is obtained from formula as follows:

Sales Growtht = 𝑁𝑁𝑒𝑒𝑒𝑒 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑡𝑡 −𝑁𝑁𝑒𝑒𝑒𝑒 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑡𝑡−1

𝑁𝑁𝑒𝑒𝑒𝑒 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑡𝑡−1

Then, the regression results between investmentt+1 and sales growtht will produce residual
values. Next, the residual values are sorted and classified in quartiles. Firms classified as
overinvesting are those that are in the upper quartile in the industry and the year of
observation, which shows the highest positive deviation rate of investment. Furthermore, this
variable is used as a dummy variable where OVERINVESTMENT is valued 1 if the firm
overinvests (in the upper quartile) and 0 if the other occurs.

The second managerial overconfidence proxy is capital expenditure. Overconfident managers

tend to invest more aggressively and have a higher level of investment than other similar
firms (Ahmed & Duellman, 2012; Campbell et al., 2011). In this study, capital expenditure is
measured using dummy variables such as Dashtbayaz and Mohammadi (2016) and Duellman
et al., (2015), where CAPEX will be equal to 1 if the results of the firm's capital expenditure
divided by the total assets of the previous year are higher than the median industry in the year
of observation, and will equal 0 otherwise.

Control Variable

One of the common problems of endogeneity is an omitted variable. This study uses several
control variables that have been proven to affect firm value in previous studies (George et al.,
2011; Leite & Carvalhal, 2016; Shah et al., 2018) to overcome the problem. This study uses a
firm size (SIZE) control variable (SIZE) measured through the natural logarithm of total
assets. Firm age (AGE) is measured using the number of years since the firm was founded.
The measured cash flow to asset ratio (CF) is divided by dividing the total cash flow from

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operating activities by the total assets of the firm. Asset growth (GROWTH_ASSET) is
measured by dividing the difference between last year's total assets, and this year with the
prior year's total assets. Financial leverage (LEV) is measured by dividing total debt by total
assets. Return on assets (ROA) is measured by dividing income after interest and taxes by
total assets.

Methodology

This study uses an ordinary least square (OLS) regression model to analyse the direction of
the relationship between managerial overconfidence, which is proxied through
overinvestment and capital expenditure with firm value using SPSS version 20. The
following is the regression equation in this study:

FVALUEi,t = β0 + β1OVERINVESTMENT + β2SIZE + β3AGE + β4CF + β5GROWTH_ASSET +

β6LEV + β7ROA + ε (1)

FVALUEi,t = β0 + β1CAPEX + β2SIZE + β3AGE + β4CF + β5GROWTH_ASSET + β6LEV +

β7ROA + ε (2)

Result and Discussion

Descriptive Statistics

Table 2: Statistic Descriptive

Variable N Minimum Maximum Mean Std. Deviation
Fvalue 381 0.070 18.640 1.6428 2.065
Overinvestment 381 0 1 0.244 0.430
Capex 381 0 1 0.501 0.501
Size 381 24.414 33.199 28.384 1.551
Age 381 2 99 35.820 13.053
Cf 381 -0.222 0.452 0.063 0.091
Growth_Asset 381 -0.477 2.170 0.907 0.205
Lev 381 0.001 1.571 0.483 0.249
Roa 381 -0.549 0.402 0.037 0.092

Table 2 shows the descriptive statistical results of the variables in this study. The firm value
variable (FVALUE) has an average value of 1.643, with a standard deviation of 2.065.
Furthermore, the overinvestment variable (OVERINVESTMENT) has an average value of
0.244, which means that 24.4% of the sample has overconfident managerial and a standard
deviation of 0.430. The capital expenditure variable has an average value of 0.501, which
means 50.1% of the sample has managerial overconfidence and a standard deviation of 0.501.
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The average size of the firm examined was 28,384, while the average age of the firm was
35,820. The variable cash flow to assets ratio has an average value of 0.063 and a standard
deviation of 0.091. Then, the average growth of the firm's assets amounted to 0.907, financial
leverage amounted to 0.483, and ROA of 0.037.

OLS Regression Analysis Result

Table 3: Regression Analysis Result

Variable FVALUE
(1) (2)
Coefficients t Sig Coefficients t Sig
(Constant) -0.746 -2.934 0.004 -0.613 -2.405 0.017
Overinvestment 0.067 2.032 0.043*
Capex 0.096 3.207 0.001*
Size 0.018 1.997 0.047* 0.012 1.317 0.189
Age -0.002 -1.398 0.163 -0.001 -1.003 0.317
Cf 0.520 2.620 0.009* 0.495 2.508 0.013*
Growth_Asset -0.040 -0.559 0.577 -0.086 -1.165 0.245
Lev 0.477 7.379 0.000* 0.477 7.439 0.000*
Roa 0.019 8.531 0.000* 0.019 8.477 0.000*

Overinvestment and Firm Value

The regression analysis results in Table 3 show that the OVERINVESTMENT variable
coefficient is 0.067 (t = 2.032) and significant at the 10% level. This result indicates that
managerial overconfidence, which is proxied by overinvestment, is positively and
significantly related to firm value. It means that if managerial overconfidence value increases
by one unit, the firm value will also increase by 0.067. These results are consistent with the
first hypothesis of the study (H1), which explains that managerial overconfidence based on
overinvestment is positively related to firm value.

A positive and significant relationship between managerial overconfidence to firm value can
occur due to two possibilities. First, Hirshleifer et al. (2012) explain that firms with
overconfident managers are more willing to take risks, including investment risks. These
managers are more effective in exploiting growth opportunities because the risks taken
generate higher returns, and then change it into firm value. This result is also supported by
research and development activities carried out so that the firm has a greater potential to
produce innovation. In the end, the firm can generate firm value better than similar firms.
Second, in line with agency theory, asymmetric information that occurs in management
(agents) and shareholders or firm owners (principals) can encourage managers to act
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opportunistically by making a variety of investments, even though the investment is not yet
done so that it causes overinvestment. This investment is made against the background of the
motive of getting incentives or efforts in showing that management's performance is high.
Those numerous investments illustrate high performance, resulting in investors are interested
in buying shares of a firm, and this contributes to the increase in the firm value of the firm.

Capital Expenditure Dan Firm Value

The coefficient value of the capital expenditure variable (CAPEX) in Table 3 shows the
amount of 0.096 (t = 3.207) and is significant at the 10% level. This amount indicates that
managerial overconfidence, as proxied by capital expenditure, is positively and significantly
related to firm value, which means that if managerial overconfidence value has increased by
one unit, the firm value will also increase by 0.096. These results are consistent with the
second hypothesis of the study (H2), which explains that managerial overconfidence based on
capital expenditure is positively related to firm value.

This result can occur due to differences in information captured by external parties or
investors in the capital market. Investors will assume that high capital expenditure is done as
an effort to develop or expand the business so that the firm still exists in the face of
competition, which will bring long-term benefits for investors, without knowing whether
these expenditures have been appropriately done both in amount and time. Information and
conditions captured from market participants are believed to be a good signal and are
reflected through an increase in share prices that illustrates the value of the related firm (Ben-
david et al., 2013).

Coefficient Determinant Test (R2)

Table 4: Coefficient Determinant Test (R2)

Model R R Square Adjusted R Square
1 0.599 0.358 0.346
2 0.607 0.369 0.357

Based on the results in Table 4, the Adjusted R Square value for the first regression equation
is 0.346 or 34.6% and 0.357 or 35.7% for the second regression equation. Thus, it can be
explained that the independent variables, namely managerial overconfidence, as measured by
overinvestment and capital expenditure, and control variables, including firm size, firm age,
cash flow to asset ratio, growth of firm assets, financial leverage, and return on assets, can
explain the dependent variable, namely the firm value, of 34.6% to 35.7%, while other
variables excluded by this study defines the remaining between 64.3% and 65.4%.

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Conclusion

This study aims to analyse the relationship between managerial overconfidence to firm value
in all manufacturing firms listed on the Indonesia Stock Exchange in the 2014-2016 period.
Based on the results of OLS regression analysis, it can be concluded that managerial
overconfidence, as measured by overinvestment and capital expenditure, has a positive
relationship to firm value. That is, firms with managerial overconfidence have a firm value or
a higher firm value compared to firms without managerial overconfidence. A positive
relationship between managerial overconfidence and firm value can be caused by
overconfident managers who are more willing to take risks and are considered more effective
in exploiting growth opportunities and change them into firm value.

The results of the study can add to the literature related to managerial overconfidence.
Besides, this study also shows that managerial overconfidence can be considered in managing
a firm because it can increase the value of the firm in the perspectives of investors. This
consideration is because in assessing the performance of firm management, investors also
deliberate the existence of managerial overconfidence, not only from aspects that can be
measured using monetary parameters. However, this study has limitations, namely, in
measuring managerial overconfidence, the determination of firms included in the category of
overconfidence is based on top quartile and median classification. Therefore, there is no
specific, definite value limit that becomes the standard reference for determining managerial
overconfidence. Thus, further research can add other measurements that involve more criteria
for managerial overconfidence measurements such as aspects of corporate investment return,
execution options, or earnings per share comparison, as in research conducted by Dashtbayaz
and Mohammadi (2016) and Kim et al. (2016), as a comparison in measuring managerial
overconfidence. Also, further research can also expand research samples from sectors other
than manufacturing firms listed on the Indonesia Stock Exchange so that the results obtained
can be more generalised.

Acknowledgement

This paper is derived from Ghanny Trianita’s Undergraduate Thesis at the Faculty of
Economics and Business, Universitas Airlangga, Surabaya, Indonesia. We are also grateful
for the comments and insights from Fajar Kristanto Gautama Putra and Melinda Cahyaning
Ratri.

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Volume 13, Issue 8, 2020

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