Doctoral thesis summary: Research on Ceo’s overconfident behavior and financial decisions in Vietnam companies

Determining the existence of the relationship between overconfidence and investment decision in Vietnam. Determining the existence of the relationship between overconfidence and investment decision in Vietnam under the effect of the financial conditions. Determining the existence of the relationship between overconfidence 6 and funding decision in Vietnam. Determining the existence of the relationship between overconfidence and funding decision in Vietnam under the effect of a financial deficit. Determining the existence of the relationship between overconfidence and dividend decision in Vietnam. Determining the existence of the relationship between overconfidence and dividend decision in Vietnam under the effect of growth opportunity.

MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

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TRUONG DINH BAO LONG

RESEARCH ON CEO’s OVERCONFIDENT BEHAVIOR AND FINANCIAL DECISIONS IN VIETNAM COMPANIES

Major: Finance – Banking Major code: 93 40201

DOCTORAL THESIS SUMMARY

HOCHIMINH CITY – 2018

The thesis is completed at:

University of Economics Ho Chi Minh City

Supervisor: Associate Professor Ph.D Nguyen Ngoc Dinh

This thesis can be found at the library:

………

SOCIAL REPUBLIC OF VIETNAM Independence – Freedom – Happiness

Ho Chi Minh City, 5 th Oct 2018

ABSTRACT OF THE THESIS

Thesis title: Research on CEO’s overconfident behavior and financial decisions in Vietnam companies

Major: Finance- Banking Code: 93 40201

PhD Student: Truong Dinh Bao Long Course: NCS2010

Supervisor: Associate Professor PhD Nguyen Ngoc Dinh,

Keywords: Overconfidence, Financial Condition Index, Financial Decisions, Regression Model, CEO (Chief Executive Officer)

CHAPTER 1 INTRODUCTION TO THE APPROACH OF THE THESIS

1.1 The necessity of the Thesis

Nowadays, in Vietnam, CEOs, who directly manage business activities, are often struggled to make good decisions Insufficient and inconsistent data, untransparent market, asymmetric information are the main causes leading to biased CEOs’ decisions This problem may become very serious and create agency cost for stockholders, it indirectly reduces the value of the company In other cases, companies can be distressed and bankrupted if such problems are not solved completely

Although doing research on CEOs’ behaviors is very important in order to contribute

to the theoretical and empirical framework in making right decisions, it is only implemented in the U.S market Therefore, it is necessary to implement and conduct

a similar research in Vietnam market because the research can reveal a specific relationship between behavioral psychology and financial theories

In types of behavior which may affect business decisions, overconfidence is the most featured and is measured almost accurately, so this point is fundamental to focus on this kind of behavior rather than others Most hypotheses, which are used in the thesis, are based on the U.S market; however, some of them are reasoned and transformed

to reflect the core of the Vietnam market In addition, the hypothesis test stage is also used to accept or reject the hypotheses and make sure the robustness of the results In summary, the necessity of the thesis is to find out whether CEOs’ behavior affects financial decisions, whether it is a good or bad relationship, then what recommendations can be given for the business

1.2 A brief of the Literature Review

The thesis is closely related to the literature about the relationship between overconfidence and corporate financial policies Malmendier and Tate (2005) prove that companies, which are managed by overconfident CEOs, has the higher sensitivity

of internal cash flow than those being run by rational CEOs Malmendier and Tate (2008) suppose overconfident CEOs are likely to involve in takeovers, so the value

of the companies is decreased Malmendier et al (2011) argue that when recognizing that the value of the company is underestimated, the CEO tends to avoid more external fundings Valeria Fedyk (2013) notes that CEO’s confidence causes two main impacts on the funding decisions The first impact is that overconfident tends to raise more debt and stocks to invest in potential projects They prefer using debt to using stock to raise fund; if CEOs estimate that the internal values of their stocks are higher than the market values of the stocks, reasonably they will sell new stocks to the market Moreover, Bouwman (2009) analyze the changes in the stock price and

an increase of dividend in companies having optimistic CEOs

In addition, the topic about the relationship between CEO’s overconfidence and financial decisions is quite new in Vietnam Recently, it received many concerns from domestic scholars For example, Nguyen Ngoc Dinh (2015) and Le Dat Chi (2015) find out some weak evidence about overconfidence can affect financial decisions However, the methodology of overconfidence measurement is still a challenge in Vietnam In this thesis, overconfidence measurement is improved significantly to those two previous papers to avoid the endogeneity

1.3 The aim of the Thesis

Determining the existence of the relationship between overconfidence and investment decision in Vietnam Determining the existence of the relationship between overconfidence and investment decision in Vietnam under the effect of the financial conditions Determining the existence of the relationship between overconfidence

and funding decision in Vietnam Determining the existence of the relationship between overconfidence and funding decision in Vietnam under the effect of a financial deficit Determining the existence of the relationship between overconfidence and dividend decision in Vietnam Determining the existence of the relationship between overconfidence and dividend decision in Vietnam under the effect of growth opportunity

1.4 The methodology of the Thesis

The thesis uses regression models on the basis of the previous papers in the U.S market The variables and the way to collect data are similar to obtain the aim of the thesis

Space dimension of the sample: Sample size includes 136 Vietnamese businesses full

of the audited financial statement and publicly listed in Ho Chi Minh Stock Exchange and Ha Noi Stock Exchange

Time dimension of the sample: The data is collected from 2007 to 2016, in which four

first years from 2007 to 2010 will be used to calculate net buying position to confirm the behavior of CEOs

1.5 A brief of the results in the Thesis

Firstly, CEO overconfidence does not affect directly on the sensitivity of cashflow Secondly, the financial condition plays an important role in reducing the sensitivity of investment-cashflow Thirdly, based on effective and efficient estimation models, the thesis finds out that CEO overconfidence increases the sensitivity of using debt under the effect of the financial deficit Fourthly, although there is no evidence to prove that CEO overconfidence affects the capital structure of the company, under the effect of financial conditions there is a weak evidence that overconfident CEOs reduce the financial leverage of the company Fifthly, overconfident CEOs pay more dividend than rational ones do Finally, under the

investment-effect of growth opportunities, overconfident CEOs still pay more dividend than rational ones do

1.6 The meaning of the Thesis

The thesis partly contributes empirical evidence related to three financial decisions (investment, funding, dividend) This thesis also makes clear the relationship between CEO overconfidence and financial decisions in the Vietnam market Investors, managers, stockholders, and related parties can use the implication of the thesis to determine the sign of the business (Does the business face debt risk? Is the CEO overconfident? Is dividend too high?)

1.7 The structure of the Thesis

In addition to the table of contents, abbreviation list, tables, annex and the Chapter 1 here The thesis includes four remaining chapters as follows: Chapter 2 Theoretical framework and literature review Chapter 3 The methodology of the thesis Chapter

4 The results of the thesis Chapter 5 The conclusions and implications of the thesis

CHAPTER 2 THEORETICAL FRAMEWORK AND LITERATURE REVIEW

2.1 Theories of Behavioral Finance about the Biased Recognition

2.1.1 Incomplete rational: Restrictive rational

Some theoretical behavioral finance models show that subjects do not adjust their belief in the right way when new information arrives It means the adjustment does not follow the Bayes rule Other models believe that subjects’ belief flows Bayes rules but their behavior is not appropriate with the expected subjective utility Therefore, these are the motivation of researchers to discover psychological

recognition of the subjects From that, behavioral financial models (behavioral economics) are based on the irrational behavior of the subjects resulting from the biasness in the personal belief and interest The models are designed to explain how subjects can create their expectations

2.1.2 Cognitive psychology: Biased patterns in Behavior

Heuristics or the rule of experiences is a thinking activity based on experienced events, it helps the subject make decisions easier Cognitive accounting is a type of behavior which helps the subject separate different decisions of the same resource This term is first expressed by Thaler (1985), when he tries to depict a process of human in which the economic results are standardized, classified and evaluated Later, Ritter (2003) contribute a descriptive process to make the model complete Another term given by Shefrin and Thaler, 1988 is framing Framing is a social scientific term including a set of definitions and description in which the subjects and organizations recognize and approach the reality The human tends to underestimate the long-run events and overestimate the most recent ones (Ritter, 2003) Almost all people have a strong, unrealistic and optimistic belief in their abilities (Weinstein, 1980) Especially, businessmen and senior managers tend to be overconfident Ritter (2003) gives the examples of low diversity which results from the familiarity of those Barber and Odean (2001) analyze the history of transactions and show that the more brokers trade, the worse their performance is

2.1.3 The overconfidence of managers in Behavioral Financial Theories

Nowadays, although senior managers are educated and trained professional knowledge and leadership skills very well, they are irrational and make wrong decisions for many reasons Almost all of the reasons result from the impact of emotion on decisions Besides, even if a CEO is considered as perfect, he must also base on his sentiment to make decisions because of insufficient information Therefore, it is hard for a person to give a good conclusion on what they observe The

reality is too different from the hypothesis of rational subjects This is the main cause explaining why a manager is irrational and biased in his decisions

2.2 Overconfidence and CEO Overconfidence

According to De Bondt and Thaler (1995), “Findings that people have overconfidence in their instinct perhaps are the most consistent findings in the psychology of making decisions” Malmendier and Tate (2005) note that managers especially senior ones tend to be affected by misperception and overconfidence They always face complex and abstract situations although they are limited by their knowledge Therefore, they often commit themselves to achieve targets in a high level, so that makes them fall into the overconfidence

2.3 The approaches of CEO Overconfidence Measurement

Malmendier and Tate (2005a, 2005b, 2008) suggest two approaches to measure the overconfidence of CEOs The first approach is based on revealed beliefs or the option and stock-based measure of CEO confidence The second approach is based on the way other people think of the CEO and is called the press-based measure of CEO confidence

2.3.1 Option and stock-based measure of CEO confidence

In this measure, there are some different methods: Holder 67, Holder 150,

Longholder and Net Buyer CEO holds their options at a level that excess their

rational threshold of 67% or 150%, so those methods are Holder 67 and Holder 150,

respectively CEO tries his or her best to hold the option 5 years longer from the maturity point even though the value of options excesses their rational level So, the

long holder measure is built on that basis On the other hand, Net Buyer measure is

created to capture the tendency of buying more stocks of some CEOs although they know the sensitivity of business risk

2.3.2 Press-based measure of CEO confidence

This measure is based on the correlation between the number of articles about overconfidence/optimistic and unconfidence/ pessimistic According to Malmendier and Tate (2005b, 2008), we can distinguish who is the overconfident CEO based on

the press Following each CEO on each year, they collect keywords such as a)

Overconfident/ overconfidence, b) optimistic/ optimism, c) unconfident/ unconfidence, d) pessimistic/ pessimism, e) reliable, cautious, conservative, practical, frugal or steady They create a dummy index Totalconfident for each CEO

2.4 The theories of CEO overconfidence and corporate financial decisions

On the aspect of investment, the theory is that CEO overconfidence impacts on investment decisions on three approaches: First, overconfidence leads CEOs to over-investment Secondly, overconfidence increase the sensitivity of investment-cashflow Finally, overconfidence leads CEOs to optimal investment Heaton (2002) shows that optimistic CEOs believe that projects will have higher cash flow and tend

to accept more projects Malmendier and Tate (2005a) regress the sensitivity of investment-cashflow to find out similar discoveries like Heaton (2002) Malmendier and Tate (2005b) show that overconfident CEO will overestimate the future rate of return; therefore, they will invest too much Goel and Thakor (2008) show that overconfident CEO, who are not risk-adverse, will invest more than the optimal investment level In terms of funding decision, Heaton (2002) and Hackbarth (2008) investigate biasness in funding decisions via optimism/overconfidence Those models give them clues that optimistic and overconfident CEOs will choose the higher financial leverage rate Hackbarth (2008) argues that overconfident CEOs believe the cash flow in their companies are less variated, then their companies have lower chances to get distressed despite that this is not true In terms of dividend policy,

Allen and Michaely (2003), Bouwman (2009), Sanjay Deshmukh et al (2013) give out empirical evidence that overconfident CEO pays less dividend than rational CEO However, under the effect of growth opportunity, overconfident CEO pay more dividend than usual

CHAPTER 3 THE METHODOLOGY OF THE THESIS

Hypothesis 1: In companies which have overconfident CEOs, the sensitivity of

investment-cashflow is higher than in companies which have rational CEOs

The thesis tests the hypothesis 1 via checking whether CEO confidence increases the sensitivity of investment-cashflow The empirical model is based on the one creating

by Malmendier and Zheng (2012) as follows:

𝐼𝑖𝑡 = 𝛽1+ 𝛽2𝐶𝐹𝑖𝑡 + 𝛽3𝑂𝐶𝑖 + 𝛽4𝑂𝐶𝑖∙ 𝐶𝐹𝑖𝑡+ 𝛽5𝑋𝑖𝑡′ + 𝛽6𝑋𝑖𝑡′ ∙ 𝐶𝐹𝑖𝑡 + 𝜀𝑖𝑡 (1) Where Iit denotes the investment (or capital expense – capex) of company i in year t using the initial year as the benchmark CFit denotes the cash flow of company i in year t, standardized and winsorized at 1% according to the asset value of the initial year OCi represents the CEO overconfidence of company i and is a dummy variable Finally, X’it is a set of controlling variables for CEO and company properties

Hypothesis 2: The sensitivity of investment-cashflow in companies which have

overconfident CEOs is affected by the effect of the funding deficit

The static model of investment (1) has an issue that it has not considered the dynamics and persistence of investment For example, investment at this moment can depend

on the investment in the previous year, and investment is the reversal in the model like this Therefore, the model (2) is now different from the model (1) Firstly, Iit-1 plays an important role as an independent variable Almost all variables are the same

as ones in the model (1) except for adding the FCI variable to present the impact of macroeconomy on the model

𝐼𝑖𝑡 = 𝛽1+ 𝛽2𝐼𝑖𝑡−1+ 𝛽3𝐶𝐹𝑖𝑡 + 𝛽4𝑂𝐶𝑖+ 𝛽5𝑂𝐶𝑖∙ 𝐶𝐹𝑖𝑡+ 𝛽6𝐹𝐶𝐼𝑡+ 𝛽7𝐹𝐶𝐼𝑡 ∙ 𝐶𝐹𝑖𝑡+

𝛽8𝑂𝐶𝑖 ∙ 𝐹𝐶𝐼𝑡+ 𝛽9𝑂𝐶𝑖∙ 𝐹𝐶𝐼𝑡∙ 𝐶𝐹𝑖𝑡+ 𝑋𝑖𝑡′Β10+ 𝑋𝑖𝑡′ ∙ 𝐶𝐹𝑖𝑡Β11+ 𝜀𝑖𝑡 (2)

Hypothesis 3: Overconfident CEOs use higher financial leverage than rational ones

Can CEO overconfidence be explained by the different capital structures in companies?

More specifically, in this thesis, is there any differential in the debt level causing by the financial deficit?

To do that, we can regress the below equation:

𝐿𝑒𝑣_𝑚𝑘𝑖𝑡 = 𝛽1+ 𝑋𝑖𝑡′𝐵2+ 𝛽3𝑂𝐶𝑖 + 𝜀𝑖𝑡 (3)

Where, 𝐿𝑒𝑣_𝑚𝑘𝑖𝑡 is the debt leverage calculated by the market value of the company

i at the end of fiscal year t 𝑋𝑖𝑡′ is the set of control variables The composition of 𝑋𝑖𝑡′

is the fiscal deficit (FD), profitability (𝑃𝑟𝑜𝑓𝑖𝑡), tangible asset (𝑇𝑎𝑛𝑔), size of the company (ln (Sales)), the growth opportunity (Q), ownership ratio of the CEO (Owp) and all measured at the beginning of year t In addition, the rest of 𝑋𝑖𝑡′ includes a return on equity (𝑅𝑒𝑡𝑢𝑟𝑛𝑖𝑡−1), the term of the CEO (𝑇𝑒𝑛𝑢𝑟𝑒𝑖𝑡), and the financial condition of the economy (𝐹𝐶𝐼𝑡) 𝑅𝑒𝑡𝑢𝑟𝑛𝑡−1 is the logarithmic rate of return over the

period from year t-2 to year t-1 Adding a return to the rate of return will reflect

changes in stock prices to the leverage ratio (Welch, 2004)

Hypothesis 4: Overconfident CEOs use more debt than rational CEOs to reduce

funding deficit

Research on the influence of CEO overconfident on debt financing in the context of the financial deficit under the approach of Malmendier et al (2011) and Malmendier and Zheng (2012) The equation is based on the theoretical framework of Shyam-

Sunder and Myers (1999) about the financial deficit of the company and is empirically tested by Frank and Goyal (2003):

𝐷𝑒𝑏𝑡𝑖𝑡 = 𝛽1+ 𝛽2𝐹𝐷𝑖𝑡 + 𝛽3𝑂𝐶𝑖 + 𝛽4𝑂𝐶𝑖∙ 𝐹𝐷𝑖𝑡+ 𝛽5𝑋𝑖𝑡′ + 𝛽6𝑋𝑖𝑡′ ∙ 𝐹𝐷𝑖𝑡+ 𝜀𝑖𝑡 (4) Where Debtit denotes the net debt, which is calculated by using incremental debt of the company i in the year t FDit denotes the financial deficit of the company I in the year t (it is calculated by adding up the cash dividend, net capital expense, net working capital and then minusing for internal cashflow) Other variables have the same as notations as the equation (1), (2) and (3) except for controlling variables Although the thesis still uses the same controlling variables as in the paper of Frank and Goyal (2003) and Malmendier et al (2011), most variables are re-calculated on the basis of the incremental changes For instance, they are the change in profitability (Δ𝑃𝑟𝑜𝑓𝑖𝑡𝑖𝑡), in tangible asset (Δ𝑇𝑎𝑛𝑔𝑖𝑡), in size of the company (Δln (𝑆𝑎𝑙𝑒𝑠)𝑖𝑡) and

in the growth opportunity (Δ𝑄𝑖𝑡)

Hypothesis 5: In companies which have overconfident CEOs, the dividend is less

than in companies which have rational CEOs

Hypothesis 6: Rational CEOs pay more dividend than overconfident CEO under the

effect of growth opportunities

According to Malmendier and Tate (2005, 2008) and Malmendier et al (2011), the thesis classifies overconfident and rational CEO based on the investment level of him/her in the company The model presents the relationship between the CEO overconfidence and dividend payment which results from the original paper of Sanjay Deshmukh et al (2013):

𝐷𝐼𝑉𝑖𝑡 = 𝛽0+ 𝛽1𝑂𝐶𝑖𝑡+ 𝛽2𝑋𝑖′ (5) Where the dependent variable is DIVit, is the total cash dividend on the market value

of the company stock in year t And, controlling variables, 𝑋𝑖′, contain a set of

variables as ownership rate on total common stock (Owp), growth opportunity (Tobin’Q) and cash flow of the company I in year t, CFit