The Impact of Managerial Overconfidence on Systematic and Unsystematic Risk

Document Type : Research Paper

Authors

Abstract

 
Introduction
       Overconfident managers overestimate future returns from their firms’ investments. Previous studies in finance documents show that overconfidence affects corporate investment, financing, and dividend policies (Malmendier and Tate, (2008); Cordeiro, (2009); Deshmukh, Goel, and Howe, (2010)).
       Risk is the potential of losing something of value. Systematic risk is vulnerability to events which affect aggregate outcomes such as broad market returns. Unsystematic risk is specific to an industry or firm. This type of risk can be reduced by assembling a portfolio with significant diversification so that a single event affects only a limited number of assets.
       The aim of the present study is to investigate the effect of managerial overconfidence on systematic and unsystematic risks.
 
Hypothesis
       To investigate the effects of managerial overconfidence on systematic and unsystematic risks, the research hypotheses have been developed as follows:
H1: There is a positive relation between overconfidence and systematic risk
H2: There is a positive relation between overconfidence and unsystematic risk
 
Methods
       For this purpose, 120 companies which were accepted at Tehran Stock Exchange during the period of 2005 to 2015 were studied. In order to measure managerial overconfidence, the model of Biddle, Hilary & Verdi (2008) based on over investment was exploited. Beta is reagent of systematic risk. In order to measure unsystematic risk, the standard deviation of the residual of CAPM was exploited.
       The Eviews statistical package was utilized for running the analysis. There is one categorical independent variable in the research: Managerial overconfidence.
 
Results
       The first hypothesis was supported. The findings showed that a significant positive relationship exists between managerial overconfidence and systematic risk.
       The second hypothesis was supported too. The findings showed that a significant positive relationship exists between managerial overconfidence and unsystematic risk.
 
Conclusion
       Recent studies in accounting and finance investigate the relation between managerial overconfidence and corporate investment, financing, and dividend policies, as well as managerial forecasts and financial misreporting. This research contributes to this literature by providing evidence on the effects of overconfidence on both systematic and unsystematic risk.
       The findings show that a significant positive relationship exists between managerial overconfidence and systematic and unsystematic risk. In other words, managerial overconfidence increases systematic and unsystematic risk.
       As overconfident managers overestimate future returns from their firms’ projects; overvalue their firms’ projects and equity; and invest in negative NPV projects mistakenly perceiving them to be positive NPV investments, it is predictable that overconfidence and systematic risk will be positively related.
       Moreover, overconfident managers tend to pay less dividends than other managers; and they tend to overinvest in assets resulting in above-average capital expenditures. Also, overconfident managers self-select into risky growth firms. So it is predictable that overconfidence and unsystematic risks will be positively related.
 
Keywords: Managerial Overconfidence, Risk, Systematic Risk, Unsystematic Risk.


 

Keywords

Main Subjects

References

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History

  • Receive Date: 06 November 2015
  • Revise Date: 19 December 2016
  • Accept Date: 14 March 2017

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