Document Type : Research Paper

Authors

• Shokrollah Khajavi ¹
• Soraya Weysihesar ²

¹ Professor of Accounting Faculty of Commerce and Finance University of Tehran,Tehran,Iran

² Department of Accounting, KAR Higher Education Institute, Qazvin, Iran.

Abstract

Efficiency is one of the most important criteria that investors consider when evaluating influencing factors to identify suitable investment opportunities. Since managers play an effective role in company decisions, they may deviate from optimal investment choices. Therefore, the purpose of this research is to investigate the relationship between CEO power and overinvestment. In this regard, 123 companies listed on the Tehran Stock Exchange were examined between 2016 and 2022. The results show that there is a negative and significant relationship between CEO power and investment inefficiency (overinvestment). Furthermore, this relationship is not nonlinear. The findings indicate that powerful CEOs do not engage in excessive investments that could create more personal benefits for them. Indeed, because of risk aversion and ability effects, the private benefits of powerful CEOs are aligned with shareholders’ interests, making them less likely to overinvest
Introduction
Efficiency is one of the most important criteria that investors consider when evaluating influencing factors to identify suitable investment opportunities. Since managers play an effective role in company decisions, they may deviate from optimal investment choices. Therefore, the purpose of this research is to investigate the relationship between CEO power and overinvestment. To explain this relationship, three different effects are discussed: the discretion effect, the risk aversion effect, and the ability effect.
Under the discretion effect, CEO power is positively related to overinvestment, because powerful CEOs have more freedom of action and may use overinvestment decisions to create personal benefits. Through empire building and expropriation, they pursue self-interest that can increase their rewards, wealth associated with stock ownership, and job security because they control capital allocation. Furthermore, CEOs can create personal bonuses through overinvestment because they influence the choice of performance measures associated with their bonuses. Under the risk aversion effect, CEO power has a negative relationship with overinvestment, because powerful CEOs are more risk-averse than shareholders who can reduce their risk through diversified portfolios. Overinvestment may increase the risk of the company. Since most of the CEO's rewards and human capital depend on their company, it is difficult for them to diversify work and wealth risks. Therefore, powerful CEOs who do not diversify and are often considered the main planners of the company's long-term strategy are more likely to make investments based on risk aversion. As a result, they are less likely to overinvest. Under the ability effect, powerful CEOs with greater management ability can make investment decisions more effectively and efficiently, and therefore are less likely to overinvest. CEOs with stronger expertise can better manage the company's external uncertainties through their experience and knowledge. Hence, powerful CEOs make more efficient investment decisions. Accordingly, the main goal of this research is to investigate the effect of CEO power on overinvestment. From the perspective of economic studies, weak supervision over CEOs, in the shadow of weak management structures and opportunities to secure personal benefits, can encourage powerful managers to choose projects with a negative net present value (NPV), thereby reducing company value. On the other hand, greater CEO power leads to more appropriate investment in valuable projects and greater investment efficiency. Factors such as risk aversion, motivation to maintain reputation and credibility, and stronger management abilities make powerful managers perform better in evaluating investment opportunities and increase investment efficiency, which aligns with organizational research.

Research Question

According to the research objective, this study seeks to answer the question of whether CEOs with higher decision-making power overinvest.

Methods

The current research is of an applied type; in terms of its goal, it is analytical, quasi-experimental, and correlational. From the time dimension of the data, it is retrospective and post-event. In line with the purpose of the research, 123 companies listed on the Tehran Stock Exchange were examined between 2016 and 2022. The residuals of Richardson's (2006) model were used to measure overinvestment. CEO power was measured using the principal component analysis method and the criteria of CEO duality, the percentage of independent directors on the board of directors, CEO tenure, and CEO ownership percentage. The information required to measure the variables and test the research hypotheses was extracted from the Rahavard Novin database, audited financial statements, and other reports published on company websites, Codal, and the Stock Exchange Organization. After data collection, Excel software was used for summarizing and calculations. Since the dependent variable, overinvestment, is not continuous and has only one of the two values (zero and one), the logistic regression (logit) model was used to test the research hypothesis with this variable. In addition, a multiple regression model was used to test the research hypothesis with the investment inefficiency variable. Finally, the analysis was performed using EViews software.

Results

The results show that as CEO power increases, investment inefficiency (overinvestment) decreases. In addition, there is no significant nonlinear relationship between CEO power and investment inefficiency (overinvestment).

Discussion and Conclusion

The findings of the research show that powerful CEOs, who have more authority than shareholders in making company decisions, do not engage in excessive investments that could create personal benefits for them. Indeed, because of the risk aversion and ability effects, the private benefits of powerful CEOs are naturally aligned with shareholders’ interests, making them less likely to overinvest. Under the risk aversion effect, since most of a CEO's rewards and human capital depend on their company, it is difficult for them to diversify work and wealth risks. Therefore, powerful CEOs who do not diversify and are often considered the main planners of the company's long-term strategy are more likely to make investments based on risk aversion. As a result, they are less likely to overinvest. Under the ability effect, powerful CEOs have higher management abilities and therefore make more efficient investment decisions. Because strong CEOs with greater managerial ability possess better knowledge and judgment than their peers, making them more capable of predicting future changes, they do not waste capital on negative NPV projects. Therefore, more powerful CEOs are less likely to overinvest. These results are in line with Lo and Shiah‑Hou's (2022) research and are also consistent with organizational theory. According to this theory, the greater the power of the CEO, the more appropriate the investment in valuable projects and the greater the investment efficiency. Factors such as managers' risk aversion, motivation to maintain reputation, and stronger management abilities lead powerful managers to use better strategies for the optimal use of company resources, thereby increasing transparency and securing the interests of all stakeholder groups. Therefore, powerful CEOs make more efficient investment decisions.
 
 

Keywords

• CEO Power
• Investment Inefficiency
• Overinvestment

Main Subjects

• stock exchange
• Accounting and various aspects of finance