Effect of CEO overconfidence, international diversification on capital structure and the moderating effect of board composition / Wan Shahdila Shah Shahar

Previous research on the determinants of capital structure of Shariah-Compliant Firms (SCFs) assume that managers are always rational. Nevertheless, the findings from these studies are not able to conclusively pinpoint the traditional theories that could best explain the capital structure decisions. In fact, there are studies found in most cases capital structure decisions as less than fully rational, which lead CEOs’ characteristics to deal with it. The characteristics possess by CEOs are associated with the act of overconfidence in choosing debt financing. This is where the role of board of directors is needed to monitor the overconfidence CEOs when it involves capital structure decisions. In addition, a lot of Malaysia public listed firms have started to engage in international diversification strategy. Involvement in international diversification is said to influence on decision to use debt financing. Therefore, this study intends to study the effects of CEO overconfidence and international diversification strategy on capital structure decision of SCFs. Furthermore, this study also intends to investigate the moderating effect of board composition on the relationship between CEO overconfidence and capital structure decision across different sectors of SCFs on the main board of Bursa Malaysia for the period 2009 to 2017. This study applies a two-step system of GMM estimation for the samples SCFs, SC industrial, and SC trading and services sector. Due to small sample size of SC consumer, SC construction and SC property sectors, the two-stage least squares (2SLS) is applied. Both methods are used to address the endogenous biases.
Empirical findings indicate that the dispersion of CEO overconfidence varies across sectors during the sample period. When using debt ratio as the dependent variables, the relationship between CEO overconfidence seems not to be significant. However, when using short term debt and long-term debt as the dependent variables respectively, the relationship between the two is obvious for certain SCF sectors. CEOs from consumer, industrial, trading and services, and property sectors are found to have stronger managerial overconfident as they prefer to use short-term debt relative to long-term debt. From the theoretical perspective, they seem to follow the prediction of Pecking Order Theory. Besides, SC of trading and services sectors use debt financing when they decided to diversify internationally, while SC industrial sector prefers other form of financing. In relation to the moderating effect of board of directors, interestingly, the findings show that internal corporate governance have greater influence for those sectors where CEOs overconfidence are more prevalent. This means that board of directors play a crucial internal corporate governance role to moderate the CEOs overconfidence relating to debt financing decisions. Consistent with the Agency Theory, most of the results show that independent and female directors emphasize the use of long-term debt instrument to moderate and discipline the overconfident CEOs.