Theories Discussion and Literature Review

2. Theories Discussion and Literature Review

Behavioral finance is a study that combining Financial Management and Psychology. Shefrin 2002 in Prasetyo 2009 explained that behavioral finance is an interaction from psychology with financial act and performance from all types of investordecision maker categories. Shefrin suggested that investordecision maker must be cautious in making mistake during the investment, for example, making judgment. Shefrin 2000 in Prasetyo 2009 stated that the mistake made by investordecision maker might be advantageous to another investordecision maker. Behavioral finance enriches the comprehension on economy by integrating human natural aspect into financial model. Wendy 2012 stated that rationality assumption has begun taking critics despite the fact that it has been the main streamin explaining individual decision making. More economists interpret literature; conclude that market phenomenon is consistent with irrationality, which is the characteristic of individuals who take complicated decision. Several empirical studies also prove that not only the factor of ratio is taken into account while taking decision, but also the factor of emotion and behavior KahnemanadTversky, 1979; Kahneman, 1992; Shefrin, 1985; Statman, 1999; Hirshleifer, 2001; and Ritter, 2003 in Wendy, 2012. The results of the studies show that besides of responding rationallycognitively, individual is also able to respond emotionally while taking financial decision. This situation emerges 2 perspectives in financial theory, particularly in analyzing capital market phenomenon, such as rational and irrational perspectives. Kiong Ting et al. 2016 did research on the effect of managerial overconfidence to the financing decision with the government ownership moderation. The research used 793 samples of companies listed on the main board of Kuala Lumpur Stock Exchange KLSE in 2002-2011 and used OLS regression, FEM, and Tobit method. The dependent variable usedto measure debt is debt ratio total asset divided by total asset and as replacement to debt ratio, debt-to-equity ratio is used to test the robustness. As for the proxy of managerial overconfidence measurement, it is done using personal characteristics of the management, such as CEO’s profile photo in annual report, CEO’s education level, CEO’s level of experience, CEO’s gender, CEO’s business network, and CEO’s past working experience. The moderation variable in the paper is the government ownership percentage, while the control variable is the concentrated 5 biggest shareholders ownership, profitability, firm size, asset tangibility, investment in research and development, and firm growth. In the early model, a test without moderation is done by dividing into 2 subsets, they are government linked companies GLC and non- government linked companies NGLC, while the second model was involving moderation. In the GLC sample, the result generated was a CEO managerial overconfidence is contributing a significant role in the financing decision-making. Besides that, the result also states that the higher the managerial overconfidence of a CEO, the lower is the debt utilized in the firm. As for the NGLC sample, it showsa contrary results to the GLC sample; a managerial overconfidence is proved not to significantly affect to the debt utilized by the firm. Therefore, the conclusion is managerial overconfidence encourages lower debt utilization, and this relation depends on the government ownership. Fedyk 2014 did research on the effect of managerial characteristic, specifically managerial overconfidence, to a firm financing decision. The research is using Fortune 500 USA companies in one-decade period as the sample. The approach to this managerial overconfidence measurement research isusingthe situation when a CEO does a press conference or known as “CEO overconfidence through optimistic press coverage”. Managerial overconfidence is reflected from the managerial act that prefers to raise debt financing to fund its investment. The purpose of this act is to allow management to have complete control to the firm and its financing decision, and is also supported by Ben-David et al. 2007 research; argued that overconfident managerialrecommends using debt to repurchase stock. For the dependent variable of financing decision, the research uses the percentage change in the number of shares outstanding measurement. Fedyk 2014 also used “strictly firm specific optimistic press percentage” as the control variable. The result of the research shows that Fedyk 2014 could not make a certain conclusion on the effect of an overconfident CEO to a firm financing decision. The next research comes from Ben-David et al. 2007, studied the effect of managerial overconfidence to firm policy. The study is done using survey method with more than 6.500 CFO or Financial Vice President in USA for the sample. The control variables in the research are past market condition and financial performance. As for theconcernedfirm policies are investment policy, financingcapital structure policy, dividend policy, market timing activity, and executive compensation. The result shows that firm with overconfident CFO will have more investments and acquisitions, and the market reacts negatively to the acquisition activities. Ben David et al. 2007 also find a positive impact of managerial overconfidence and financing structure, in which a firm with overconfident CFO tends to have more debts, depends on long-term debt and low dividend payment. Finally, Ben-David et al. 2007 also found that compensation payment to executives in a firm with overconfident CFO is based on the performance. A dissertation by Scheinert 2014 explained the effect of managerial optimism to a firm financing decision. The result generated is that managerial traits have a significant impact on various financing decision by the management. Since manager is the decision maker in a firm, naturally, manager individual characteristicswill affect the firm decision. In the classic financial literatures, they only focus on fundamentals and rationality to explain financing decision, while behavioral traits show a significant contribution to understand many decision aspects in finance and accounting field. Therefore, behavioral bias must not, in general, be negatively viewed, but can be considered as a context that will affect decision-making process. Managerial optimism encourages taking a decision exposed to risk-taking, which might affect stakeholders negatively, but also might positively affect stakeholders on the other hand. Fairchild 2007 studied the effect of managerial overconfidence on financing decision and firm value when investor is faced to hazard moral of a management team. The research is divided to 2 groups. The first group is for the manager who operates the firm in a low efficiency managerial shrinking, in which he will use debt to motivate the business. Overconfident management is likely to overestimate its ability and underestimate the expense of financial distress. Therefore, in this condition, Fairchild 2007 predicted a positive effect of managerial overconfidence to debt. In the next group, manager has incentive to use free cash flow to invest in new projects that might decrease firm value the free cash flow problem. In the second group, managerial confidence has a negative effect on debt. The results are that the first group managerial shrinking is able to prove managerial overconfidence positive affect on debt; meanwhile, the second group the free cash flow problem is proven to have a negative effect on debt. However, the effect of managerial overconfident to the firm value is still ambiguous.

3. Data and Methodology