Investigating the Relationship between Overconfidence Management and Investment Performance with Emphasis on the Mediating Role of Internal Financing

Overconfidence is an interdisciplinary concept related to the possibility of misjudgment in psychology. More importantly, management overconfidence is a concept derived from behavioral financing. Overconfidence can define unfounded belief in one's cognitive abilities, judgments, and intuitive reasoning. Overconfidence is one of the most important personality traits of managers that affect risk-taking companies in prioritizing their financial resources in terms of cost. Companies prefer to use the domestic budget and then the external financial resources as a last resort to issuing new shares. Because managers with overconfidence feel optimistic about the profitability of their business, they assume the capital market is underestimating their stock. In cases where the entity needs financing, they prefer financing through issuing bonds instead of issuing shares and think they may increase the wealth of shareholders by choosing debt with a short-time maturity. Overconfidence is irrational behavior, and corporate executives express it when making business decisions. The purpose of this study is to investigate the relationship between overconfidence management and investment efficiency with emphasis on the mediating role of internal financing In the companies listed on the Tehran Stock Exchange, TSE, over the period 2009-2018.  

Data collection completed using modern software, financial statements of the TSE official website. To test the research hypotheses, we used a panel data model with Eviews software. In this research, the statistical sample consists of information and data of 101 companies from the TSE. This study tests five hypotheses. The logarithm of total assets was used to measure the control variable of company size, and the ratio of long-term debt to total assets to measure the financial leverage control variable.  Also, the ratio of net profit to total assets was used to assess the control variable of return on assets, and the ratio of net profit to equity to assess profitability.  

Overconfidence in management has a positive and significant relationship with internal financing. Internal financing has a positive and significant relationship with overinvestment and a negative and significant relationship with underinvestment. Internal financing does not have any mediating effect on the relationship between management overconfidence and investment efficiency. Control variables are firm size, financial leverage, return on assets, and profitability. The difference between earnings per share and real earnings per share measures the management distrust. The logarithm of the accumulated profit and legal reserves measure the variable of domestic financing, and investment efficiency is divided into two variables of over-investment and under-investment.

As managers become more confident, their willingness to use internal resources increases, and as internal financing rises, managers tend to invest more. Manager's distrust is an essential factor in financing so that managers with overconfidence incline to raise domestic financing and investment more than others.