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Archives of Business Research – Vol. 9, No. 10
Publication Date: October 25, 2021
DOI:10.14738/abr.910.11032. Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non- Sharia Compliant Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
Services for Science and Education – United Kingdom
CEO Compensation, Managerial Overconfidence and Performance
of Sharia Compliant Firms and Non-Sharia Compliant Firms:
Evidence from Listed GCC Firms
Gaafar Mohamed Abdalkrim
Department of Business Administration
College of Science and Humanity- Al Sulail
Prince Sattam Bin Abdulaziz University, KSA.
ABSTRACT
Background: The positive relationship between managerial overconfidence and
performance implies that overconfident managers overestimate their ability to
create value and improve their firm’s performance, which also lead to overestimate
their own firms returns by taking over other firms. Purpose: The study examines
relationship between managerial overconfidence, CEO compensation, and
performance of sharia compliant firms and non-sharia compliant firms for 207 GCC
listed firms from 2010 to 2014. Methodology: The study sample comprised of 207
firms for the main empirical analysis. The data used in this study were collected
from GCC stock exchange data-base and firms financial report provided by website
argaam.com between 2010 and 2018. Findings: The study found that managerial
overconfidence is positively and significantly related to firm performance. CEO
compensation and managerial overconfidence is also associated positively with
sharia–compliant firms’ performance. The findings supported first hypothesis that
managerial overconfidence leads to better firms’ performance. Originality: The
study has revealed a positive impact of sharia compliant firms’ managerial
overconfidence on firm performance. Furthermore, the effect of CEO compensation
is favorable in sharia compliant firms.
Keywords: CEO compensation, Managerial overconfidence, Non-Sharia compliant firms,
Performance, Sharia compliant firms.
INTRODUCTION
The study of the managerial over-confidence is developed under a behavioral corporate finance
theory whose underpinning foundation is the cognitive psychology literature with the belief
that people in general are too optimistic (Wei Huang et al 2011). Previous studies on
psychology and corporate finance have already authenticated that overconfident manager tend
to overestimate (under overestimate) the probability of achieving good (poor) firms’
performance, which leads to incorrect evaluation and unrealistic expectation (Yizhong Wang et
al 2016; Cooper and Dunkelberg 1988).
Several recent researches focus on how managerial overconfidence proxies affect corporate’s
performance (Anlin Chena and Cheng-Shou Lu 2015). The relationship between CEO
compensation, managerial overconfidence, and performance is mostly well-understood and
documented. Mark Humphery-Jenner et al. (2016) argued that overconfident CEOs receive
more option-intensive compensation and this relationship increases with CEO bargaining
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power similarly. Lien and John (2015) found that the proxies of job complexity and firm stock
market performance are positively related to the level of CEO compensation. The positive
relationship between managerial overconfidence and performance implies that overconfident
managers overestimate their ability to create value and improve their firm’s performance,
which also lead to overestimate their own firms returns by taking over other firms.
Dissemination information about building advance understanding of overconfidence is a
central to growing literature since managerial overconfidence is one of the most important
factors affecting firms’ performance. Scholars have shed light on significant queries whether
and how management overconfidence affects corporate performance (Amel Kouaib and Anis
Jarboui 2017; Goel and Thakor 2008). Therefore, the study is motivated to examine the effect
of managerial overconfidence on performance of sharia compliant firms and non-sharia
compliant firms.
The study has used a panel data from 2010 to 2015 excluding the financial companies because
firms in this sector are administered by different set of instructions and rules. The data used in
this study were collected from two sources: (1) GCC stock exchange data-base and (2) firms
financial report. This study has adopted two indicators of managerial overconfidence to
investigate the effect of managerial overconfidence on firm performance of sharia compliant
companies versus non- sharia compliant firms. The study has tested whether there is any
difference between sharia compliant firms and non-sharia compliant firms. Furthermore, the
study is consistent with agency theory that the main goal of management is to serve the
interests of the capital’s owners (Amel Kouaiba and Anis Jarboui 2017). The study has further
examined the interaction effect of CEO compensation on the relation of overconfidence and firm
performance.
This study contributes to the literature in different ways. Firstly, the effect of financial styles of
top managers on risk and performance has been addressed. Secondly, this study investigates
the financial styles of managers who switch from or to sharia and non-sharia compliant firms
for explaining modifications risk and performance of firms. This study, for examining these
issues, utilizes the data on sharia firms in the GCC. Sharia compliant firms are progressively
dominant after the international financial crisis of 2008-09. The market, according to Robinson
(2007), for the financial products of sharia compliant firms has elevated by 30% throughout
the last few years. Thirdly, Naz, Shah and Kutan (2017) explored the impact of financial styles
of strategic financial decisions, dividend policy of sharia and non-sharia compliant firms, and
working capital for finding that managers play an important role to explain the difference in
financial decisions. On the contrary, Naz, Shah and Kutan (2017) emphasize merely on financial
decisions, whereas this study addresses concerns associated to risk and performance in sharia
and non-sharia compliant firms.
In particular, there is sufficient evidence for recommending that managerial financial styles can
impact idiosyncratic risk and firm performance. On the contrary, the literature pays minimal
attention to the direct role played by managers in order to explain cross-sectional difference in
idiosyncratic risk and firm performance in sharia compliant firms. There are merely a few
empirical studies. For instance, the effect of financial styles of managers on financial decisions
has been explored by Naz, Shah and Kutan (2017) for the UK and Pakistan. They create, for
every firm, a manager-firm matched panel data for identifying the top executives across the
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
variations in financial decisions and revealed that a significant role was played by managers to
explain the variations in financial decisions across the firms and the financial styles of managers
who move between a sharia and non-sharia compliant firm.
In this study, the managers may further play a role to explain cross-sectional differences in risk
and firm performance as risk and performance are the consequences of financial decisions.
According to Wooi and Ali (2015), there is no substantial variation in performance of non- sharia and sharia compliant firms, but the firms with Muslim CEOs revealed significantly lower
performance than the firms with non-Muslim CEOs. They further found that Muslim-dominated
board can enable the lower performance of the firm with Muslim CEOs, and significantly, the
lower performance can be reduced if the dominant owner had a higher extent of control over
the company. Another essential outcome is that the Muslim CEOs can contribute positively to
the firm’s performance if the owners possess more controlling rights.
The study findings provided a more thorough understanding of how managerial
overconfidence can influence firm performance and also findings could hold important
implications for practitioners seeking to improve performance by efficiently designing and
implementing executive compensation packages. Moreover, to best of the author’s knowledge,
this study is among the first to examine the effect of CEO compensation, managerial
overconfidence, and performance of sharia compliant firms and non-sharia compliant firms
among listed GCC Firms. Lastly, this study has intended to study the neglected link between the
dynamic effect of the interaction of managerial overconfidence and CEO compensation because
previous studies considered them as two independent and un-related topics.
The remainder of this paper is structured as follows: The next section reviews the literature on
overconfidence, examines the interaction of CEO compensation and overconfidence, and
development the research hypothesis. Section three describes data and sampling process along
with variable construction. Section four presents descriptive statistics, empirical results, and
hypotheses analysis. Conclusions, implications, and limitations are presented in section five.
THEORETICAL BACKGROUND
Compensation and Performance of Firms
Previous studies have capitalized performance measurements under either accounting or
marketing indictors since only measurable things are manageable. For financial measure,
Return on Assets (ROA) measure is used by net income over total assets at the end of the year
(Al-Manaseer et al 2012; Mehul 2016). Return on Equity (ROE) can be analyzed by profit after
tax/ total equity shares in issue (Obiyo and Lenee 2011; Rouf 2011). Return on Sales (ROS) is
calculated by dividing net profit by sales (Geletkanycz and Boyd 2011). Return on Investment
(ROI) is calculated by dividing the benefit (return) of an investment on the cost of the
investment (Adjaoud, Zeghal and Andaleeb 2007) and Profit Margin (PM) which can be
evaluated by Profit after tax / Turnover.
The review of 375 cases of acquirement with overconfidence by Johansson and Olvebrink
(2013) showed that CEO’s compensation and overconfidence are decreased due to unbound
board. However, managerial overconfidence is not affected by duality of CEO responsibility.
Another study by Baccar et al. (2013) narrated that managerial optimism and overconfidence
is affected by lack of CEO duality and failure to comply with the organizational rules. The
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
Table 1: Summary of all Variable Definitions
Variables code Variables name Operation definition
Performance measure (dependent)
Q Tobin-Q Ratio of the market capitalization plus
total debt divided by total asset
ROA Return on assets (Net Income) / (Total Assets)
Overconfidence & Compensation
(indep)
Over-invest Overinvestment Equal 1if the residual of regression is in
the top quartile for the industry- year
and zero otherwise.
RO_PERF Recent
organization
performance
Stockholder return divided by the initial
stock price.
Tot_comp Total
compensation
The sum of salary, bonus, the total value
of restricted stock granted the total
value of stock options using long term
incentive payout, and all other payment.
Cash_com Cash compensation CEO’S salary plus bonus provided by
Execucomp
Control variables
LEV Debt ratio dividing the total debt with the total
assets
PAYOUT Dividend payout
rate
Cash dividend / earnings.
PROF Profitability Earning divided by total capital
Tang Tangibility Fixed assets divided by last period total
assets
Year Year Year Dummy variable
IND Industry Industry Dummy variable
LITERATURE AND HYPOTHESIS DEVELOPMENT
This section provides a literature review and present hypotheses development based on the
objective of this study. First, the study has investigated how CEO overconfidence affect firm
performance. Secondly, the study has examined the effect of CEO compensation on the
relationship between overconfidence and firm performance.
The Effect of Overconfidence on Performance
There is an increasing literature on the impact of CEO overconfidence on corporate
performance. Overconfidence is vigorous phenomenon in the psychology. In financial
literature, it is considered as a systematic overestimate of the precision of own knowledge and
imply an underestimation of the variance of random variables (Lukas Menkhoff et al 2013).
Overconfidence is also defined as the overestimation of one’s ability, performance, chance of
success, or level of control (Nathan Meikle et al 2016). Researchers share a considerable
interest in managerial overconfidence and its relationship with firm performance. Previous
research in behavioral finance has provided mixed and conflicting findings particularly
regarding the influence of overconfidence on dividends, investments, and on mergers and
acquisitions.
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Overconfidence as competitiveness factor has been addressed in a few studies. For instance,
Englmaier (2006), in this theory paper, investigates whether it might be preferable for a
company to recruit an overconfident manager for strategic causes. Furthermore, firms may
prefer to delegate to overconfident managers under both a linear demand Cournot model and
a tournament type version of Bertrand competition where the firms have the chance in carrying
out cost mitigating R&D prior to their entrance into product market competition. Similarly, Kyle
and Wang (1997), in their theory paper, claim that overconfident traders might create higher
anticipated utility and profitability as overconfidence acts as a commitment instrument in
Cournot duopoly. Therefore, both funds recruit overconfident managers and overconfidence
can survive and persist in the long-run because of prisoner’s dilemma. In addition, Ando (2004)
investigates two different overconfidence sources and compare the behavioral outcomes of
each situation. The overconfidence sources always persuade the aggressive behavior of
participants, while the aggressive behavior is brought among one or both participants. These
outcomes recommend that product market performance is enhanced by overconfident CEOs as
witnessed in the previous papers (Gervais, Heaton and Odean 2011; Goel and Thakor 2008;
Hirshleifer et al, 2012). This likelihood is labeled as the positive competitive performance
hypothesis. Overconfident CEOs result effectively throughout industry sales performance
under this hypothesis. On the contrary, overconfident CEOs are disadvantageous to firm value
as they may interact in activities that disengage from maximizing shareholder value. These
outcomes recommend that overconfident CEOs affect adversely firm competitive performance.
Goel and Howe (2012) found that the level of dividend payout is lower in firms managed by
overconfident CEOs. Malmendier and Tate (2005) found that, between 1980 and 1994,
investment of overconfident CEOs is significantly more responsive to cash flow, particularly in
equity-dependent firms Amel Kouaiba and Anis Jarboui (2017) have pursued a new direction
in the analysis of behavioral finance based on examining whether future performance of the
firm is related to overconfidence displayed by the Chief Executive Office. On the negative side
of overconfidence, Heaton (2002) has claimed that overconfidence negatively influences firm
value as it may decline positive net present value and invest in negative net present value
projects, which lead to decline investment efficiency. However, there has been little empirical
analysis of the relationship between overconfident CEOs and the general performance of the
firm. As the relationship between overconfidence and performance remains an open question,
neglecting future firm performance may reduce firm’s competitiveness and the potential of
individual firms as well as the whole economy.
According to Dashtbayaz and Mohammadi (2016), the relationship of CEO overconfidence with
leverage has a negligible but negative influence on firm value. A positive impact is shown by
overconfident managers on firm value by shifting investment levels closer to its optimal level.
In particular, the relationship of CEO overconfidence with innovation has a positive impact on
firm value. Similarly, Dev and Moore (2018) have shown that the advantages of positive
feedback are not moderated by overconfidence. The study has also explored the accuracy of
predictions of how positive feedback will affect self-efficacy, anxiety, self-esteem, and
performance. Individuals who have a high confidence level have a tendency to avoid the
information available. It should be noted that individuals with a high confidence level will be
secure from the effects of the information sequence (Almilia and Wulanditya 2016). Mistakes
were negatively correlated with overconfidence in future price forecasting. Overconfidence
was not correlated with risk aversion and had no impact on experimental consequences
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
(Michailova, Mačiulis and Tvaronavičienė 2017). Thus, following hypothesis is derived based
on the aforementioned discussion:
Hypothesis 1A. There is positive relationship between Sharia compliant firms’ managerial
overconfidence and firm performance.
Hypothesis 1B. The positive relationship between managerial overconfidence and performance
Sharia compliant firms is stronger as compared to non-Sharia compliant firms.
The Interaction of CEO Compensation and Overconfidence
The second hypothesis is inspired by existing body of literature that examines the relationship
between managerial overconfidence, CEO compensation, and firm performance. Since CEO
compensation directly influences managerial overconfidence, it is logical to investigate the
effects that CEO compensation and overconfident managers have on corporate performance
and firm value because compensation and overconfident impact firm performance not only
through their own impact but also through their interaction effect. The concept compensation
examined in this study is defined as the sum of base pay, bonuses, stock grants, stock options,
other forms of compensation, and benefits.
Takao Kato et al (2007) found that cash compensation of Korean executive is significantly
related to stock market performance. Accordingly, Mahoney and Thorn (2006) also found a
positive relationship between executive compensation and corporate social performance of
Canadian firms. Berrone and Gomezmejia (2009) also showed a positive relationship between
executive compensation and environmental performance. Contrary to evidence documented in
prior literature, Sudhir Shive and Asish Kumar (2016) have examined the role of board ship
and CEO characteristics in CEO compensation and found that CEO compensation is not
associated with board characteristics instead with firm’s attributes and its CEO’s tenure. In a
similar study, Faiz-ul Haque (2017) has examined the effect of board characteristics and
sustainable compensation policy on carbon performance of UK firms and find mixed evidence.
Zhao and Ziebart (2017) have hypothesized and showed that overconfident CEOs and CEO
compensation are positively associated to extreme innovation consequences such as
innovation failures and innovation breakthroughs. According to Aktas, Louca and Petmezas
(2019), CEO overconfidence has a positive influence on the cash value among firms that are
more likely to experience from the underinvestment issue. Furthermore, the value of cash in
firms is negatively affected by CEO overconfidence that financially unconstrained.
Overconfident CEOs are considered as better-than average and involved with over-investment
and showed dominant performance for the firm. Firm performance is increased by the
overconfident CEOs by following optimal levels of investments (Mundi and Kaur 2019). CEOs
have better incentives to temporarily possess unconstrained equity where excess incentives
have slower balance speed, and greater impact on firm performance (Bushman, Dai and Zhang
2018).
In particular, an overconfident person overestimates finding associated to own competencies
(Alicke 1985; Larwood and Whittaker 1977). Thereby, high incentive compensation motivates
an overconfident CEO since the respective individual will overestimate the value of such
benefits and the possibility that thresholds with respect to these benefits will be fulfilled
(Gervais et al, 2011). In addition, an overconfident CEO has a tendency to overestimate the
value of incentives (Otto 2014; Humphery-Jenner et al, 2016). Such overestimation, for a
predefined incentives level, is potentially to be related with an elevation in corporate risk. It is
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anticipated that a likely positive relationship between corporate risk and CEO incentive
compensation, in line with this justification, is increased when dealing with overconfident
CEOs. Likewise, a potentially positive relationship between CEO overconfidence and corporate
risk has been anticipated due to this amplification and receiving high incentive compensation.
The literature on the significance of managers is very limited for risk-taking behavior and
performance of managers in the context of sharia compliant firms, but there are some
associated studies, addressing different elements of Islamic business and finance. On the
contrary, these studies do not emphasize on the role of manager in this context. The
performance of mutual funds has been studied by Mansor and Bhatti (2011) in Islamic and
conventional portfolios and revealed no variation in between returns of Islamic portfolios and
those of traditional ones. They further report that the Islamic portfolio is riskier as compared
to the conventional portfolios. They claim that the possible reason for this untraditional
outcome is that the market penetration is minimal for Islamic portfolios but its volatility is
higher as compared to that of conventional portfolios. However, it is claimed that financial
styles of managers may assist to explain such different risk attributes of sharia and non-sharia
compliant firms. Based on above literature review, following hypothesis is derived;
Hypothesis 2A. There is positive relationship between CEO compensation and managerial
overconfidence that affect firm performance.
Hypothesis 2B. The positive relationship between CEO compensation and managerial
overconfident in Sharia compliant firm is stronger as compared to non-Sharia compliant firm.
METHODS
Data
The study has examined the relationship between managerial overconfidence and firm
performance of sharia compliant firms and non-sharia compliant firms. Secondly, this study has
investigated the effect of CEO compensation on this relationship. The initial sample consist of
all firms listed on GCC countries stock exchanges, which is filtered to 207 firms for the main
empirical analysis with reason of missing data. To calculate overconfidence and compensation,
the study has also excluded the financial companies’ sector because firms in this sector are
administered by different set of instructions and rules based on previous studies (Abed et al
2012; Al-Fayoumi et al. 2010). The data used in this study were collected from two sources;
GCC stock exchange data-base and firms financial report provided by website argaam.com from
2010 to 2018.
Based on prior studies (Omer Farooq, Amal Alahkam 2016; Omer Farooq 2013), the study has
used the classification provided by Dow Jones Index in classifying the firm sample into two
categories sharia compliant firm and non-sharia compliant firm. The Index has provided two
criteria for identifying three ratios including leverage, cash, and liquidity. All ratios had to be
less than 33% for sharia compliant firm. A second criterion is that Islamic compliant firms are
prohibited to generate revenues from alcohol, pork, arms manufacture, gambling, and
conventional financial services. In Table 2, the number of sharia compliant firms and non-sharia
compliant firms are presented.
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
Table 2: Sharia- and Non-Sharia-Compliant Firms in Different Countries
Sharia-compliant firms Non-sharia-compliant firm
Countries Number of firms-Frequency Number of firms-Frequency
Panel A: Sharia-and Non-Sharia-Compliant Firms in Different Countries
Saudi Arabia 54 (37.7%) 16 (25%)
Bahrain 08 (5.6%) 1(1.6%)
Qatar 25 (17.5%) 18(28.1%)
Kuwait 16 (11.9%) 6 (9.4%)
Oman 23 (16.1%) 16 (25%)
United Emirates 17(11.9%) 7 (10.9%)
Panel B: Sharia-and Non-Sharia-Compliant Firms in Different Industries
Cement 10 (07%) 5 (7.8%)
Retail 14 (9.8%) 6 (9.4%)
Petrochemical Industrials 19 (13.3%) 9 (14.1%)
Agriculture and food 25 (17.5%) 7 (10.9%)
Real-State development 12 (8.4%) 4 (6.3%)
Consumer services 14 (9.8%) 8 (12.5%)
Telecommunication 4 (2.8%) 2 (3.1%)
Utilities 6 (4.2%) 2 (3.1%)
In a view of data availability, the study has constructed two proxies for firm performance in this
study. The first proxy is Return on Assets (ROA), (account- based measure), which can be
evaluated by net income over total assets at the end of the year. The second proxy is Tobin-Q
(market- based indicator), which can be estimated by the ratio of the market capitalization plus
total debt divided by total asset of the company. Victor (2014) defines firm size as a natural log
of firm’s total assets.
Empirical Models
The central idea of this study is to examine the effect of managerial overconfidence on firm
performance of sharia–compliant firms (SCF) and non-sharia compliant firms. Using firm
performance (perf) as dependent variable, the study has regression model 1 as follows;
Perf!" = β# + β$Overinvest!" + β%RO&'()!" + β*LEV!" + β+Payout!" + β,PROFT!" + β-Tang!" +
∑ β!year! + ∑ β".Industry" + it (1)
Where perf is the firm performance, subscript I and t represent the firm and time, respectively.
Yeari =Year dummy; Industryt = industry dummy; εit is error term. Β, 1-6, are coefficients of the
respective independent and control variables.
The study has explored the interaction between CEO compensation and overconfidence on firm
performance consistent with the predictions. The study has added CEO compensation as
interactive term in Model 1 and used the following regression model.
Perf!" = β# + β$Overinvest!" + β%RO&'()!" + β*compit ∗ over_confid + β+LEV!" + β,Payout!" +
β-PROFT!" + β/Tang!" + ∑ β!year! + ∑ β".Industry" + it (2)
The estimation of the proposed models is conducted on a panel data. According to Baltagi
(2005), panel data gives multiples solutions to many problems related to cross-sectional
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specification like unobserved heterogeneity, degrees of freedom, dynamics, and collinearity
among the explanatory variables.
RESULTS AND DISCUSSION
This section has presented the aggregate sample for the empirical study variables and
univariate result. In panel B, the study has presented means, median, and standard divisions
for the variables. The study has further separated the sample into sharia compliant firm versus
non-sharia compliant firm. The first three columns presented descriptive statistics for non- sharia compliant firms and the next three columns report descriptive statistics for sharia
compliant firms. The study has observed Debt ratio (Leverage), which is higher for non-sharia
compliant firms than sharia compliant firms. It is identified that higher levels of debt will cause
a decrease in firm performance and this is consistent with Dow Jones Islamic index requirement
for a firm to be sharia compliant (Leverage less than 33%).
Table 3 presents the correlation coefficient matrix between the two-overconfidence measure,
performance indicator, and control variables. The study has found a positive correlation
between Q (performance measure) and two proxies of overconfidence. On the other hand, a
negative correlation between ROA (performance measure) and RO_PERF (overconfident
measure) was found. It is essential to analyze multivariate regression result, before drawing
statistical inference in this regard.
To ensure there is no multicollinearity among variables, Pearson correlation analysis is
conducted. The results of the correlation analysis examining the degree of multicollinearity
among the regressors are shown in Table 3. Furthermore, the values of correlation coefficients
are all below 0.6 in absolute terms indicating that there is no evidence of multicollinearity
among the variables. Furthermore, the study has checked the variance inflation factors (VIF)
test. If VIF is not bigger than 10 this means that there is no problem with multicollinearity (Hair
et al 2006). Hence, multicollinearity is unlike to affect the main result and no variables should
be excluded from the multivariate analysis (Irene Wei Kiong Ting et al, 2016).
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
Table 3: Summary Statistics
Panel A full sample (N = 207 observations)
Variables Mean St. dev Median Max Min
Tobin-Q 0.422 0.485 0.000 1.000 0.000
Return on assets 0.012 0.022 0.010 0.090 -0.070
Overinvestment 0.433 0.494 0.000 1.000 0.000
Recent organization
performance
0.228 0.418 0.000 0.930 0.003
Total compensation 6.689 0.688 6.001 6.800 0.000
Cash compensation 5.699 0.962 4.237 5.000 0.000
Debt ratio (leverage) 0.474 0.215 0.483 1.136 0.044
Dividend payout rate 0.654 0.454 0.200 2.201 0.000
Profitability 1.056 0.914 0.840 5.856 0.123
Tangibility 1.056 0.912 0.838 5.000 0.134
Panel B: Sharia compliant firm versus non-sharia compliant firm
Non-sharia compliant firm (N
=64)
sharia compliant firm (N =143)
Variables Means Median Std. Dev Means Median Std. Dev
Tobin-Q 0.163 0.067 0.247 0.194*** 0.085 0.274
Return on assets 0.253 0.161 0.289 0.292*** 0.193 0.305
Overinvestment 0.353 0.269 0.315 0.329*** 0.016 0.313
Recent organization
performance
0.465 0.400 0.329 0.665** 0.600 0.528
Total compensation 0.161 0.141 0.121 0.152 0.132 0.111
Cash compensation 0.121 0.120 0.001 0.110 0.100 0.020
Debt ratio
(Leverage)
0.147 0.149 0.117 0.170 0.158 0.133
Dividend payout
rate
0.310 0.016 0.331 0.470** 0.120 0.391
Profitability 0.114 0.090 0.119 0.111* 0.094 0.116
Tangibility 0.477 0.483 0.263 0.666 0.727 0209
*** Denotes statistically significant at the 1% level. ** Denotes statistically significant at the 5%
level. * Denotes statistically significant at the 10% level.
Table 4 reports correlation coefficient between the main variables which are defined in Table
2 and variance inflation factors (VIFs). The study has found that the two proxies of managerial
overconfidence measures are positively correlated with each other.
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Table 4: Correlation Analysis
Q ROA Over- invest
RO_PERF LEV PAYOUT PROF Tang VIF
Q 1.000 3.52
ROA 0.075 1.000 2.75
Over-invest 0.040 0.049 1.000 2.66
RO_PERF 0.025 -
0.036
0.2234 1.000 1.50
LEV -0.016 0.058 -0.057 0.060 1.000 2.78
PAYOUT 0.782 0.085 0.8000 0.752 0.696 1.000 1.46
PROF 0.040 0.050 0.096 0.020 0.030 -0.040 1.000 3.22
Tang 0.0210 0.054 0.038 0.443 0.155 0.085 0.128 1.000 1.54
The study has examined a positive impact of sharia compliant firms’ managerial overconfidence
on firm performance. Moreover, the study has shed a light on the relationship between CEO
compensation and overconfidence with firm performance of sharia compliant firms versus non- sharia compliant firms. Fee et al (2013) raise the question as to whether CEOs imprint their
own desirers on the firm or are chosen to integrate the desires of the board. Therefore, it is
essential for identifying whether the CEOs have different financial styles than to those who shift
from a non-sharia compliant firm. The dependent variable was regressed against fixed effects
control variables and other fixed effects in equation 1 for capturing the fixed effects of the CEO.
This study then computed the residuals for the sharia and non-sharia compliant firms. It should
be noted that these residuals reflect the fixed effect of CEOs.
Table 5: Impact of CEO Overconfidence on Firm Performance
Variables Tobin-Q Return on assets (ROA)
Intercept 0.0191(1.621) 0.0152 (0.010)
Over-invest 0.685***(0.839) 0.682***(0.840)
RO_PERF 0.401***(0.597) 0.432***(0.588)
LEV -0.051**(0.001) -0.058** (0.001)
PAYOUT 0.665*(0.014) 0.669*(0.097)
PROF 0.552 (0.020) 0.444 (0.011)
Tang 0.004 (0.194) 0.008 (0.705)
Year fixed effect Yes Yes
Industry fixed effect Yes Yes
Adjusted. R2 0.633 0.621
Observation 207 207
*** Denotes statistically significant at the 1% level. ** Denotes statistically significant at the 5%
level. * Denotes statistically significant at the 10% levels for a two- tailed test.
Table 5 reports the regression result of managerial overconfidence and firm performance. The
study has conducted a logistic regression to investigate whether there is a positive relationship
between overconfidence and firm performance. Overinvestment is consistent with Duellman et
al (2015) and recent organizational performance as proxies for overconfidence and two proxies
(Tobin-Q and Return on assets) as firm performance indicators. Primarily, the study has found
a positive and significant coefficient at the level of 1% between the two measures of firms
across two indicators of managerial overconfidence. This finding indicates that CEO
overconfidence positively influences firm performance, which accepts Hypothesis 1.
Page 13 of 19
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Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
As shown in table 5, the coefficient of interaction term (0.017) is positively and significant at
the 10% level, which supports Hypothesis 2. Such a result suggests that the effect of CEO
compensation is favorable in sharia compliant firms and the effect is stronger for sharia
compliant firms than non- sharia compliant firms. This suggests that CEO compensation might
be considered an alternative device to motivate managerial overconfidence and as a result
reflected on high firm performance.
With respect to the control variables, the finding shows a negative and significant coefficient on
Debt ratio (Leverage) but a positive significant coefficient on payout at the 5% and 10% levels,
respectively across two measure of performance. The coefficients of Leverage indicate that
managerial overconfidence would lead to a lower level of leverage. Low leverage allows sharia
firms to distribute high dividend. Profitability and tangibility are also positively significant
across two performance measures (Table 6). The evidence from the correlation analysis shows,
as expected, a strong positive correlation between the control variables size and firm age, and
both potentially have an impact upon overconfidence.
Table 6: Impact of CEO Compensation on Overconfidence and Firm Performance
Tobin-Q Return on assets
Variable Sharia
compliant
Non- sharia
compliant
Total
sample
Sharia
compliant
Non- sharia
compliant
Total
sample
Intercept 0.183
(0.09)
-1.732**
(0.02)
-1.501** 1.185
(0.88)
-0.125**
(0.75)
0.145**
Over-invest 0.125***
(3.64)
0.151***
(3.10)
0.776
(5.66)
0.157**
(3.29)
0.104***
(3.17)
1.256***
(5.20)
RO_PERF 0.297
(0.08)
0.110
0.06)
0.444
(0.09)
1.056
(0.19)
0.098
(0.15)
1.054
(0.87)
Tot_comp 0.161***
(0.172)
0.166***
(0.185)
Cash_com 0.142***
(0.004)
0.140***
(0.006)
Copm*over_conf 0.017*
(1.94)
0.017*
(1.80)
LEV 0.032**
(0.026)
-0.028**
(0.028)
0.752**
(0.021)
0.035**
(0.32)
0.030**
(0.22)
0.176**
(0.29)
PAYOUT 0.030***
(0.02)
0.018**
(0.03)
0.045**
(0.06)
0.033**
(0.03)
0.011**
(0.01)
0.561**
(0.08)
PROF 0.007***
(0.04)
0.109
(0.03)
0.111
(0.06)
0.005***
(0.04)
0.001***
(0.00)
0.018***
(0.11)
Tang 0.020**
(0.02)
-0.015
(0.02)
0.070
(0.05)
0.151
(0.01)
0.165
(0.01)
0.199
(0.08
Year fixed effect Yes Yes yes yes
Industry fixed
effect
Yes Yes Yes Yes
Adjusted. R2 0.76 0.73 0.70
Observation 143 64 207 143 64 207
Brackets contain p-values and superscripts
,
, and
denote significance at 1%, 5%, and
10%, respectively.
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The present study has shown that irrationality of management as the result of behavioral biases
of executive managers is critical in corporate governance. A company’s value is likely to get
affected negatively due to managerial overconfidence. In accordance with the present study,
previous studies have also confirmed that risk-taking motivation decreases costs for
overconfident directors (Campbell et al. 2011; Gervais et al. 2011). These factors need to be
controlled as overconfidence and non-compliance with Shariah laws may increase the conflicts
between their interests and management`s interests (Baccar et al. 2013).
The study has some important limitations suggesting directions for future studies, which
should be considered. Firstly, the study has only investigated non-financial companies and
financial companies have been excluded because firms in this sector are administered by a
different set of instructions. Secondly, the study has only two proxies as indicators for
managerial overconfidence though there are lots of measures used in literature (e.g., options- based measure introduced by Malmendier and Tate 2008).
Robustness Checks
The regression outcomes for CEOs in Sharia and Non-sharia compliant firms were reported in
Table 7. The findings based on a regression analysis were discussed for the movement of CEOs
in sharia and non-sharia compliant firms. The residuals of new firms were regressed for
checking the robustness of the findings for all decision variables. The findings have indicated
that the decisions of CEOs are same in both firms who moved from one sharia compliant firm
to another. This is because of the nature of the firms. The findings for CEOs who move from
non-sharia to sharia compliant firms are statistically insignificant.
Table 7: Robustness Checks
Coefficient p-value
Sharia Compliant Firm (CEO)
ROA 0.057 0.000
Over-invest 0.024 0.049
RO_PERF 0.052 0.000
LEV 0.061 0.011
PAYOUT 0.827 0.580
PROF 0.410 0.567
Tang 0.211 0.451
Non-Sharia Compliant Firm (CEO)
ROA 0.023 0.000
Over-invest 0.054 0.000
RO_PERF 0.046 0.011
LEV 0.078 0.034
PAYOUT 0.231 0.043
PROF 0.567 0.056
Tang 0.125 0.231
MANAGERIAL IMPLICATIONS
The findings have important implications for managerial overconfidence and performance.
Firstly, the study has proposed explanation for the overconfidence puzzle reported by other
studies. According to Hirshleifer et al., (2012), it might be observed that overconfident CEOs
are better innovators and can effectively interpret growth opportunities into firm value. The
Page 15 of 19
173
Abdalkrim, G. M. (2021). CEO Compensation, Managerial Overconfidence and Performance of Sharia Compliant Firms and Non-Sharia Compliant
Firms: Evidence from Listed GCC Firms. Archives of Business Research, 9(10). 159-177.
URL: http://dx.doi.org/10.14738/abr.910.11032
findings have indicated that the relationship of overconfident CEOs with innovation positively
influenced firm value in other industry segments. Furthermore, overconfident CEOs are able
for contributing to firm value using their investment behavior.
Secondly, firms might be more inclined to emphasize their recruitment efforts particularly to
attract overconfident managers if moderate and high overconfidence levels have a positive
influence on firm value. Thirdly, the incentives of overconfident managers and shareholders
should be aligned with option-based compensation for mitigating the detrimental effects of CEO
overconfidence on corporate policies. In particular, overconfident manages are in favor to
introduce additional mechanisms.
The results presented in this study would be helpful for the owners and investors in process of
decision making considering various aspects. As it shows that the responsibilities of managers,
capital expenditures, managerial overconfidence, and CEO compensation need more attention
to evaluate the capability of listed companies to pay back the investment. The testing of internal
controls of companies with Shariah laws compliance decreases on the effectiveness of
corporate governance mechanisms to prevent managerial overconfidence.
The present study contributes to growing literature presenting several originalities, as it is
more closely related to the literature that investigate the effect CEO overconfidence on
performance. This study has complemented the literature by using performance in sharia
compliant firms offering an attempt to fill the void and build for a better understanding of
managerial overconfidence and firm future performance. Second, focusing on GCC listed firms,
this study has explored the interaction between CEO compensation and overconfidence on firm
performance consistent with the predictions. The study has also found that the performance
was positively related to compensation and overconfidence. This suggests that CEO
compensation might be considered an alternative device to motivate managerial
overconfidence and consequently reflects on a high firm performance.
CONCLUSION
This study has examined the relationship between overconfidence and firm performance of
sharia-compliant firms and non-sharia compliant firms of GCC listed firms as well as the effect
of CEO compensation on this relation. The study has provided interesting insights for
researchers and decision-makers for improving the understanding of managerial
overconfidence and performance and enriching the literature on managerial overconfidence
and firm performance. After controlling for monitoring proxies, the study has found that
managerial overconfidence is significantly related to firm performance. CEO compensation and
managerial overconfidence were also correlated positively with sharia–compliant firms’
performance. This finding has suggested that CEO compensation might be considered an
alternative device to motivate managerial overconfidence and as a result reflect on high-firm
performance.
Nevertheless, this study is the first of its kind conducted on managerial overconfidence and
performance of sharia–compliant firms’ and non- sharia compliant firms in GCC listed firms. It
is suggested that other overconfidence measures should be included in future studies and the
managerial overconfidence and other variables should be examined using an additional sample
with comprehensive statistical analysis including the moderating effects of demographic items.
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Moreover, the results of present study should be replicated considering both financial and non- financial firms.
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