Abstract

The problem of over-investment of free cash flows has been heavily debated in the financial literature of companies. However, only a handful of studies have examined this problem in the context of behavioral finance. The objective of this article is to study the effect of the manager’s overconfidence on the over-investment of the free cash flows. We construct a proxy measure of overconfidence and we use Richardson’s model to measure over-investment expenditure. Our empirical study was conducted on a sample of 150 US companies and for a period from 1995 to 2012. Our results show a positive and significant relationship between over-investment and free cash flows. Also, we find the positive relationship is greater when managers are highly confident. The results generated by this study confirm that investment distortions are associated with behavioral attributes or biases.

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