Corporate financial management and managers’ (ir)rationality

Abstract

The aim of this paper is to analyze how managers who are characterized by optimism and excessive self-confidence, as forms of bias and irrationality, manage corporate finances. The assumption of the perfect rationality of an average man, from which the proponents of traditionalist economic views proceeded, proved to be unfounded in practice and was rejected by modern economics. Limited rationality and the absence of rationality in making economic decisions by the average person are accepted as real phenomena. The thesis that managers are more rational than average people is also called into question. Irrationality can occur in various forms. This paper deals with two forms of irrationality: optimism and excessive self-confidence, and factors that affect their level. It is considered how the optimism and excessive self-confidence of managers affect the profiling of investment, financing and dividend payment policies. Furthermore, factors that control actions of biased managers are presented. The results of the analysis of the relevant literature demonstrate that biased managers mainly rely on internal and short-term external sources of financing, invest significantly more and with greater risks than average managers, and generally pursue a residual dividend policy.