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Agency cost, top executives' overconfidence, and investment-cash flow sensitivity -- Evidence from listed companies in China

Wei Huang, Fuxiu Jiang, Zhibiao Liu and Min Zhang

Pacific-Basin Finance Journal, 2011, vol. 19, issue 3, 261-277

Abstract: We examine the effect of agency cost on the relation between top executives' overconfidence and investment-cash flow sensitivity using the data from Chinese listed companies. We find that on average top executives' overconfidence leads to increased investment-cash flow sensitivity. However, this relation holds only for companies with state-owned entities as controlling shareholders. In contrast, the relation is not significant for non-state controlled firms. We construct proxy for agency cost and find that state-controlled companies have significantly greater agency cost than non-state controlled companies. Results on sub-samples sorted by agency cost again show that the positive effect of top executives' overconfidence on investment-cash flow sensitivity holds only for companies that exhibit high agency cost. Our results therefore suggest that agency cost has a significant impact on the relation between top executives' overconfidence and investment-cash flow sensitivity, and the investment distortion due to top executives' overconfidence behavior may be alleviated by reducing agency cost through elevated supervision.

Keywords: CEO; overconfidence; Agency; cost; Investment-cash; flow; sensitivity; China (search for similar items in EconPapers)
Date: 2011
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