Determining the Effect of Managerial Overconfidence on Share Price: Evidence from Some FTSE / JSE Top 40 Index Companies

Abstract

The discipline of corporate finance has undergone numerous transformations over the past two-and-a-half decades. A rich body of research in economics, finance, and even psychology has found evidence that managers are sometimes irrational. Driven by certain behavioral biases, it has been reported that managers sometimes make subjective decisions that do not always follow traditional corporate finance norms. One such behavioral influence is overconfidence or optimism. There is a paucity of research on the impact of managerial overconfidence through corporate investments on the general movement of a company’s share price. The present study sought to bridge this gap by investigating the share price of 10 companies from the JSE/FTSE top 40 index. The objectives were to Estimate managerial overconfidence, determine the relationship between managerial overconfidence and company size, determine the effect of managerial overconfidence on corporate investments, and determine the effect of managerial overconfidence on share price. The results show the presence of managerial overconfidence observed through the investment-cash flow sensitivity of firms. The fixed effects panel regression reveals that Tobin’s Q, which is the proxy measure of the investment-cash flow sensitivity of a firm, does affect the share price. Holding every other explanatory variable constant, an increase in Tobin’s Q causes the share price to rise, thus suggesting that managerial overconfidence does have influences on the stock price.  It is further observed that managerial overconfidence tends to increase with firm size. This is made evident by the weak but positive correlation between the Q ratio and LnTA, and Q ratio and sales.