Behavioral Corporate Finance Research Articles

Subjective Well-Being of Chief Executive Officers and Its Impact on Stock Market Volatility During the COVID-19 Pandemic in Poland: Agent-Based Model Perspective

This study aimed to connect the behavioral corporate finance perspective (micro level) with complexity theory via agent-based modeling to analyze the impact of selected psychological factors of chief executive officers (CEOs) on stock market volatility (macro level). Specifically, we wanted to explore whether Polish CEOs’ subjective well-being (SWB) influenced their managerial decisions during the COVID-19 pandemic and how it might be related to the volatility of stock prices during this critical period in Poland. Our study was based on a survey of Polish CEOs who managed companies listed on the Warsaw Stock Exchange. In particular, 255 CEOs completed the Satisfaction with Life Scale, the Positive and Negative Affect Scale, and a business survey on the impact of the COVID-19 pandemic on company management. Using the results of this survey, we built an agent-based model to investigate how CEOs’ decision-making, stemming from their SWB levels, influences the perception of prices by individual traders and, in turn, how it is translated into aggregate stock market volatility. The results indicate the pathways through which the microscopic-level SWB of CEOs influences market price formation at a macroscopic level. The findings obtained from our model may shed new light on the rational expectations theory applied to stock market volatility during the financial crisis.

Behavioral Corporate Finance

Managers and corporate directors need to recognize two key behavioral impediments that obstruct the process of value maximization, one internal to the firm and the other external. I call the first obstruction behavioral costs. Behavioral costs, like agency costs, tend to prevent value creation. Behavioral costs are the costs associated with errors that people make because of cognitive imperfections and emotional influences. The second obstruction stems from behavioral errors on the part of analysts and investors. These errors can create gaps between fundamental values and market prices. When they do, managers may find themselves conflicted, unsure of how to factor the errors of analysts and investors into their own decisions. Proponents of value based management emphasize that with properly designed incentives, managers will maximize the value of the firms for which they work. As such, either they treat behavioral costs as simply another form of agency costs, or they deny the relevance of cognitive errors. In contrast, proponents of behavioral finance argue that behavioral costs are typically large, and cannot be addressed though incentives alone. This is not to say that incentives are immaterial. On the contrary, incentives are of critical importance. The point, however, is that there are limits to incentives. If employees have a distorted view of what is in their own self-interest, or if they have a mistaken view of what actions they need to take in order to maximize their self-interest, then incentive compatibility, although necessary for value maximization, will not be sufficient.

CEO POWER AND RISK-TAKING: INTERMEDIATE ROLE OF PERSONALITY TRAITS

In our paper we discuss how different personal characteristics of a CEO, being affected by CEO power, may in turn affect personal risk-taking. Agency theory states that managers have non-changing risk preferences and are either risk-averse or risk-neutral. In contrast to that, there may be cases, when managers are risk-seekers and power of executives is positively related to excessive risk-taking. Additionally, agency theory assumes that CEOs are homogenous in power use and ignores difference of CEOs in term of personality traits as well as its impact on corporate decisions. Therefore, our aim is to focus specifically on factors that connect CEO power with CEO risk-taking and to analyze possible effects of that relationship on firm. Based on both psychological and managerial studies, we conclude that, on the one hand, CEO’s power can affect CEO’s personal traits by producing [in the case of overconfidence or hubris] or by enhancing them [in case of narcissism]. On the other hand, CEO’s personal traits affect CEO’s risk-taking. It can be either by changing the perception of risk or because of behavior patterns inherent to those traits. Finally, we hypothesize that CEO power can affect CEO personal risk-taking through personality traits. By examining relationship between CEO power and CEO risk-taking based on individual-level determinants, our paper adds to the behavioral corporate finance and corporate governance literature.

Irrationality of managers’ behavior in corporate financial decision making

Purpose of the study: The subject of consideration is the behavioral aspects of corporate finance. The consideration is devoted to the basic inclinations of psychological nature characteristic of managers. The main purpose of the article is to characterize the irrational behavior of managers in the process of financial decision-making in the enterprise.
 Methodology: The paper was prepared with the use the critical literature review method mainly in the field of behavioral corporate finance.
 Main findings: The discussion shows that behavioral corporate finance focuses mainly on cognitive and motivational-emotional processes in managers, which may occur in various decision areas within which managers make choices. There are three groups of psychological phenomena and inclinations that are characteristic of managers who manage business entities, namely predispositions to systematic inference errors, heuristics, and the presentation effect.
 Application of the study: The presented article refers to the irrational behavior of managers in the process of making financial decisions in the company. It implies reflections in such scientific fields as, among others, economics and finance, management and psychology. The use of the tools of psychology allows analyzing the problems of financial decision-making of managers in the enterprise, noticing in them some deviations from rationality that can affect the efficiency of the enterprise. The content of the article can be useful for managers making financial decisions in an enterprise.
 Originality/Novelty of the study: Behavioral finance is a young discipline of finance, the scientific output of which in Poland is still small. Behavioral aspects are just beginning to gain importance in the decision-making process, especially the financial one. The tendencies of managers to irrationality in the decision-making process presented in this article allow us to better understand the errors, psychological factors that may cause wrong decisions, which in turn may translate into poorer financial condition of the whole enterprise. The article can inspire further research and inquiry in the field of behavioral finance and contribute to other interesting scientific studies.

What is CEO overconfidence? Evidence from executive assessments

We use detailed assessments of CEO personalities to explore the nature of CEO overconfidence as it is commonly measured. Longholder, the option-based measure of CEO overconfidence introduced by Malmendier and Tate (2005a) and widely used in the behavioral corporate finance and economics literatures, is significantly related to several specific characteristics that are associated with overconfident individuals as well as individuals with lower ability. Similar relations hold for overconfidence measures based on CEOs’ earnings guidance. Investment-cash flow sensitivities are larger for both Longholder and less able CEOs. After controlling for ability and other characteristics, Longholder CEOs’ investments remain significantly more sensitive to cash flows. These results suggest that overconfidence, as measured by Longholder, is correlated with lower ability but still reflects empirically distinct aspects of overconfidence.

Managerial overconfidence in capital structure decisions and its link to aggregate demand: An agent-based model perspective.

This study aims to connect two strands of the psychology and economics literature, i.e., behavioural finance and agent-based macroeconomics, to assess the impact of managerial overconfidence at the micro and macro levels of the economy as a whole. We build a macroeconomic stock-flow consistent agent-based model that is calibrated for the specific case of Poland to explore whether the overconfidence of top corporate managers in the context of their initial capital structure decisions is detrimental for the firms being managed in this way, the financial market dynamics, and the selected macroeconomic indicators. We model heterogeneous firms with different capital structure decision criteria depending on their degree of managerial overconfidence. Our model also includes a complete macroeconomic closure with aggregated households, capital producers, banking, and a public sector. We find that firms with overconfident managers outperform in terms of investment and size but are also more fragile, thereby making them more likely to default. Finally, we run policy shocks and show that while investors' flight to liquidity creates financial turmoil and increases the probability of default. This paper contributes to the knowledge base by linking behavioural corporate finance and agent-based macroeconomics. In general, the excess overconfidence on the micro level, either an increase in the proportion of overconfident firms or a higher degree of overconfidence among managers, has a strong destabilizing impact on the economy as a whole on the macro level.

Behavioral Corporate Finance

The second part of this series of articles, representing a preprint of my two-volume book „Behavioral Corporate Finance“, deals with the younger stream of Behavioral Corporate Finance, namely the approach of irrational managers and rational investors, which is discussed in detail in chapter 7 of the book. In particular, this stream analyzes how, in a world with rational investors, irrational managers destroy shareholder value. In this article, this is shown at the example of overconfident managers that make corporate investment decisions. The article presents and analyzes three effects of managerial overconfidence that may lead to value-destroying capital budgeting decisions.

Behavioral Corporate Finance

Behavioral Corporate Finance

Managerial Overconfidence in Initial Public Offering Decisions and Its Impact on Macrodynamics and Financial Stability: Analysis Through an Agent-Based Model

This study aims to connect the two strands of literature, i.e. behavioral corporate finance and agent-based macroeconomics to assess the impact of managerial overconfidence both at the micro and at the macro level. More specifically, we build a macroeconomic Agent-Based Model (ABM) calibrated for the specific case of Poland to explore whether overconfidence of top corporate managers in the context of their Initial Public Offering (IPO) decisions is detrimental or not for the firms being managed in that way, for the financial market dynamics and the selected macroeconomic indicators in Poland. We modelled heterogeneous firms with different IPO decision criteria depending on degree of managerial overconfidence. Our model also included a banking sector and a stock market that interact with the real economy. We found that there is a contradiction between the micro and the macro impact of overconfidence. Overconfident firms showed better performances in terms of output than other firms. But they were also more exposed to stock market volatility which makes them more likely to default. Higher default rate of overoptimistic firms negatively impacted the banking sector and increases financial instability. In turn, financial instability harmed the economy as a whole. We also observed that an increase in the proportion of overconfident firms is associated with a decrease in aggregate output although overconfident firms showed better individual performances. Finally, we run policy shocks and show that the increased financial instability can be offset by strengthening regulation of the banking sector.

What Is CEO Overconfidence? Evidence from Executive Assessments

We use detailed assessments of CEO personalities to explore the option-based measure of CEO overconfidence, Longholder, introduced by Malmendier and Tate (2005a) and widely used in the behavioral corporate finance and economics literatures. Longholder is significantly related to several specific characteristics and is negatively related to general ability. These relations also hold for overconfidence measures derived from CEOs’ earnings guidance. Investment-cash flow sensitivities are larger for both Longholder and less able CEOs. Overall, Longholder CEOs have many of the same characteristics traditionally associated with overconfident individuals, including lower general ability, supporting the interpretation of this measure as reflecting overconfidence. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Behavioral Corporate Finance: The Life Cycle of a CEO Career

Behavioral Corporate Finance: The Life Cycle of a CEO Career

Overconfidence and Initial Public Offering (IPO) decisions: a behavioural corporate finance survey among polish managers

Overconfidence and Initial Public Offering (IPO) decisions: a behavioural corporate finance survey among polish managers

Sermaye Yapısı Üzerinde Etkili Faktörler: Davranışsal Kurumsal Finans Bağlamında Bir Panel Veri Analizi

Bu çalışmada firmaya özgü ve makroekonomik faktörlerin yanı sıra “Reel Kesim Güven Endeksinin” sermaye yapısı üzerindeki etkisi araştırılmıştır. Reel kesim güven endeks verileri davranışsal kurumsal finans çerçevesinde yapılan çalışmalara paralel olarak yöneticilerin kendine aşırı güvenlerinin bir ölçüsü kabul edilmiştir. Çalışmada dikkate alınan diğer değişkenler net satışlar, aktiflerdeki değişim, aktif kârlılığı, gayri safi yurtiçi hâsıla ve enflasyondur. Çalışmada sermaye yapısı değişkeni olarak kaldıraç oranı kullanılmıştır. BIST SINAİ endeksi firmaları üzerine yapılan çalışmada panel veri analizi yöntemi kullanılmıştır. Çalışma sonucunda Reel Kesim Güven Endeksinin sermaye yapısı üzerinde bir etkisi tespit edilememiş bununla birlikte diğer değişkenlerin sermaye yapısı üzerinde belirli düzeylerde etkisi tespit edilmiştir.

Economic situation, the key to understanding the links between CEOs' personal traits and the financial structure of large private companies.

Executives act based on their experiences, values, personality and personal interpretation of the situations which they face in their companies. Investigations in the field of Behavioral Corporate Finance have determined that there are some relations between CEOs’ personal traits and financial decisions of large companies, but these results are based on indirect personal trait measurements and on public companies. To see whether such relations also exist between CEOs’ personal traits and the financial structure of large private companies, we used psychometric tests to measure their level of optimism, risk attitude and affect heuristic, collected financial data for a period of fourteen years, and considered the economic situation of the country as a key factor in these relations. This paper reports the relationship of executives’ personal traits with the financial structure of large Spanish companies for the period 2001–2014. We observed that executives’ high optimism (and risk aversion attitude) is positively (negatively) related to long-term debt, whilst positive affect is directly associated to the financial leverage and short-term debt. This paper also reports a change of relations when taking into account the country’s economic situation. In effect, by considering this new variable, executives’ risk aversion is seen to be associated to financial leverage and short-term debt, whilst CEOs’ positive affect is linked to long-term debt. These relations are strongly moderated and they become statistically significant in a contracting economic period. In conclusion, the links between CEOs’ personal traits and financial structure of large private Spanish companies make sense when the effect of the economic situation is taken into account. Furthermore, the awareness of these links helps to understand the financial decisions taken within large Spanish companies.

DECISÕES CORPORATIVAS EM GRUPO: UMA ABORDAGEM COMPORTAMENTAL

Important organizational decisions are commonly made within groups. Within financial institutions, it is not rare for credit concessions to be decided by committees. In the government sphere, fundamental decisions, such as defining the economy’s primary interest rate, are also made in collegiate. In large private companies, the board of directors is at the top of the organizational hierarchy and has the final word on investment strategies, financing, and mergers and acquisitions. However, the peculiarities of the group decision process are widely ignored in finance literature, which usually considers the group as if it were an individual. For example, studies in the field of behavioral corporate finance emphasize the cognitive processes and biases of the individual decision maker, but pay little attention to how these processes interact to make a group decision (For a literature review, see Baker & Wurgler, 2013). In this essay, I present, in a concise, selective manner, the current state of the emerging multidisciplinary discussion on the decision process in small groups and emphasize its behavioral aspects. First, I cover the advantages and difficulties of the group decision compared with the individual decision. Then, I present recent contributions indicating that the quality of group decisions depends on the context and on how small changes in the decision environment can have important consequences.

Behavioral vs. Traditional Corporate Finance: An Unabashed Critical Review

Research in behavioral corporate finance has accumulated to the point that it may now be a viable contender as an alternative to traditional corporate finance. This review consists of three parts. First, I discuss the foundations behind these two competing theories. I clarify concepts such as rational versus irrational behaviors of managers contrasted with those of the investors. Second, I make side by side comparisons and a critical examination of the two theories in the main topic areas of dividends, capital structure, and investments. Part three gives practical suggestions on how practitioners may use behavioral finance in their dealings as well as avoid known behavioral biases.

Managerial Overconfidence, Self-Attribution Bias, and Downwardly Sticky Investment: Evidence from Korea

ABSTRACTThe extant literature on behavioral corporate finance has explored the effects of overconfidence on investment–cash flow sensitivity (ICS) to explain overinvestment, yet it has overlooked the asymmetric behavior of investments in relation to changes in cash flow levels. This study examines whether investments behave asymmetrically responding to changes in cash flows and, if so, how managerial overconfidence affects asymmetric ICS. Using a sample of KOSPI and KOSDAQ firms in Korea, we find the incidence of downwardly sticky ICS in unconstrained firms. We then find that overconfident managers encourage ICS to be stickier than their rational peers do in unconstrained firms. Finally, we find that managerial overconfidence intensified by self-attribution bias induces ICS to get even stickier, suggesting more explicit evidence of corporate investment distortions. The results of alternative tests using the asymmetric models of Homburg and Nasev (2008) are qualitatively consistent with prior results. Overall, our findings imply a higher incidence of excessive investment commitments driven by overconfident managers.

Behavioral Corporate Finance

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Behavioral Biases as An Effective Factor for the Firm Financial Decision-Making: A Literature Review

Decision-making process is a multi-faceted and complex process. Decision making can be defined like a process of choosing from among a number of alternatives. It will not contribute enough to be fully understood and to effective decision making to be addressed only from the rational point of view. Behavioral finance is an integral part of the decision-making process. Individuals can improve their performance by recognizing the biases which discussed in the framework of behavioral finance. Understanding the possible negative effects of biases allows to the individuals to make better choices and they can avoid repeating the expensive errors in future. Result of investigations of behavioral biases on decision-makers in the firms, managerial bias issue has been raised. The studies show the effect of managerial biases on many financial decisions in firms. This paper investigated the role of biases such as overconfidence, loss aversion, optimism, anchoring, narrow framing, self-serving attribution, disposition effect etc. on financial decisions such as investing, financing, equity market, capital structure etc. This study review of 30 international studies related with behavioral corporate finance and behavioral biases that affect financial decisions in firms. The studies were gleaned from Web of Science and Google Scholar. The main contribution of this study to the literature is this study brings out the impact of behavioral biases on financial decisions in the firms by summarizing the previous studies. In this sense, this work also has an assembly quality. Therefore, this is also intended with this study that to transfer the knowledge and intellectual formation about the impact of behavioral bias on the financial decisions. In this paper, most important behavioral biases in the behavioral finance literature will be addressed.

The Indirect Impact of Overconfidence on the Performance of Tunisian Firms Through their Financing Structure

In the current framework of behavioral corporate finance, this article studies the relationship between the managers’ overconfidence and firm performance through the financing structure in the Tunisian context. Our model seeks to identify if the financing structure as a mediating variable between the performance and overconfidence. The empirical study is based on a sample of 56 firm managers for the year 2014. The results of the conducted regressions confirm the existence of a mediating effect of the financing structure on the relationship between overconfidence and the performance of Tunisian firms.