Behavioral Corporate Finance Research Articles

Corporate Governance, Institutional Environment, Behavioral Corporate Finance and Inefficient Investment

This paper is the literature review of extensive literature about how inefficient investment is influenced. It discusses in three factors: corporate governance, institutional environment and behavioral corporate finance. Academics concern how the conflicts of shareholders and creditors, shareholders and managers, controlling shareholders and minority shareholders cause inefficient investment through the game. However, an enterprise is not isolated, it operates in various connections with external institutional environment. Academics interest in how formal institution such as legal environment, financial system, government intervention and informal institution like political connection impact inefficient investment. Besides, human behaviors have certain social and individual psychology background, then the crossover study of corporate finance and psychology gradually becomes a cutting-edge issue. The paper concludes the effects of investor psychology on inefficient investment by classifying psychological bias derived from investment decisions, investment execution and investment performance feedback.

CEO's personal characteristics, ownership and investment cash flow sensitivity: Evidence from NYSE panel data firms

This study tries to extend previous works on behavioral corporate finance by examining the interaction between investment cash flow sensitivity and various CEO characteristics in either the existence or inexistence of managerial optimism. Using a Q-investment model and departing from a sample of 475 annual observations, our results highlight that CEO's financial education, CEO's ownership and their optimism bias can explain distortions in corporate investment policy since they affect investment cash flow's relationship.

Investment cash flow sensitivity under managerial optimism: New evidence from NYSE panel data firms

Investment cash flow sensitivity constitutes one important block of the corporate financial literature. While it is well documented in standard corporate finance, it is still young under behavioral corporate finance. In this paper, we test the investment cash flow sensitivity among panel data of American industrial firms during 1999-2010. Using Q-model of investment (Tobin, 1969), we construct and introduce a proxy of managerial optimism following Malmendier and Tate (2005a) to show the impact of CEOs’ optimism in the relationship between investment and internal cash flow. Our results report a positive and significant coefficient of investment to cash flow for the full sample. While, on estimations of our model using sub-sample of more and less constrained firms, we find that the sensitivity exists stronger only for totally constrained group. We find also that board characteristics can reduce investment policy's distortions.

Investment Cash Flow Sensitivity under Managerial Optimism: New Evidence from NYSE Firms Panel Data

Investment cash flow sensitivity constitutes one important block of the corporate financial literature. While it is well documented in standard corporate finance, it is still young under behavioral corporate finance. In this paper, we test the investment cash flow sensitivity among panel data of American industrials firms during 1999-2010. Using Q-model of investment (Tobin 1969), we construct and introduce a proxy of managerial optimism following Malmendier and Tate (2005a) to show the impact of CEOs optimism in the relationship between investment and internal cash flow. Our results report a positive and significant coefficient of investment to cash flow for the full sample. While, estimations of our model using sub-sample of more and less constrained firms, we find that the sensitivity exist and stronger only for totally constrained group. We find also that board characteristics can reduce investment policy’ distortions.

Investment Cash Flow Sensitivity and Managerial Optimism: A Literature Review Via the Classification Scheme Technique

In this paper, we present a literature review and classification scheme for investment cash flow sensitivity under behavioral corporate finance. The former consists of all published articles between 2000 and 2011 in different journals that are appropriate outlets for BCF research. The articles are classified and results of these are presented and analyzed. The classification of articles was based on nine criteria; journals, date of publication, paper nature, the context of the study adopted behavioral biases, adopted approach, behavioral biases measurement, the adopted assumption, econometric approach and empirical findings. Literature on investment cash flow sensitivity under behavioral corporate finance isn’t well developed. In fact, the behavioral corporate finance is very young. Our review shows that behavioral biases (optimism and overconfidence) have an explanatory power and they can succeed to explain the dependence of corporate investment on the internal cash flow availability. This result is protected in the most cases by the some restrictive assumptions: the absence of agency costs and asymmetric information. Based on the review, suggestions for future research are likewise provided.

How to Make Better Decisions? Lessons Learned from Behavioral Corporate Finance

This article reviews the literature in the field of Behavioral Corporate Finance. For reasons of simplicity, we distinguish between two approaches. The first approach focuses on the analysis of irrational behavior of managers in the context of efficient financial markets. Many empirical studies discover systematic irrational managerial behavior. The second approach regards rational manager decisions in the context of inefficient markets. The analysis focuses on situations where investors are systematically irrational taking rational and well-informed managers as given. Interestingly, Behavioral Corporate Finance is able to explain many empirical observations that cannot be explained by traditional Corporate Finance. In reality, both managers and investors act to some extent irrationally. Therefore, we make recommendations to both groups in order to improve their decision making. In contrast to other papers, we give specific recommendations for both managers and investors. With the help of these recommendations, managers and investors are able to improve decision-making to their mutual advantage.

Does Corporate Governance Affect Managerial Optimism? Evidence from NYSE Panel Data Firms

Previous research in behavioral corporate finance has demonstrated that managerial optimism has an explanatory power and it can explain observed distortions in corporate decisions. What makes it special is its being a major source of investment cash flow sensitivity and it can affect the firm value since it causes overinvestment or overinvestment (Heaton in Financ Manag 31(2):33–45, 2002; Malmendier and Tate in J Financ 60(6):2661–2700, 2005a, Eur Financ Manag 11(5):649–659, 2005b; Pacific-Lin et al. in Basin Financ J 13:523–546, 2005; Huang et al. in Pac Basin Financ J 19:261–277, 2011). However the behavioral corporate finance literature is still silent about the ability of corporate governance mechanisms to affect the CEOs’ optimism bias. In this paper, we present an original essay that aims to discuss the determinants of managerial optimism by adopting a corporate governance framework. We concentrate especially on the effect of corporate governance mechanisms regarding this bias. We construct a managerial optimism using the “Net Buyer” criterion as developed by Malmendier and Tate (J Financ 60(6):2661–2700, 2005a) and we regress directly the optimism measure to some well-documented mechanisms of corporate governance. We also explore the effect of some CEO’s personal characteristics on the emergence of managerial optimism. Departing from a sample of American manufactures’ firms, we find strong evidence concerning the effect of internal corporate governance structure on managerial optimism bias.

Impact of Biased Pecking Order Preferences on Firm Success in Real Business Cycles

Studies on behavioral corporate finance have documented that overconfident managers invest more than their more rational peers. Reasons include that overconfidence reduces managers’ ability to perceive risk correctly. However, although it has been addressed in several theoretical models, the impact of overconfidence on firm success has received little empirical examination. Based on a unique 10-year panel dataset of German chief executive officers (CEOs) and their companies, we investigate the relationship between overconfidence and firm success. In line with principal agent theory and the hubris hypothesis, we find negative effects of CEO overconfidence during economic recessions. However, we also find a strong positive impact of CEO overconfidence on firm profitability and stock market performance during the early phases of the business cycle. These novel insights imply that overconfidence operates using different mechanisms in routine than in one-time situations. In particular it hints at heightened individual effort and work performance of overconfident individuals as described in psychological studies. Our findings suggest a reciprocal relationship between macroeconomic developments and microeconomic decision-making, a finding that may help to illuminate aggregated patterns such as herding and investment bubbles and the current economic and financial crisis.

From behavioural to emotional corporate finance: a new research direction

Behavioural finance and behavioural corporate finance analyses the effects of psychological biases, heuristics, and emotions on investors’ and managers’ decision-making and performance. Taffler and Tuckett (2005) have introduced a major paradigm shift by introducing a new field of research, namely emotional finance . This ground-breaking approach employs Freud’s theory of phantastic objects to analyse the effect of unconscious, infantile, emotions on investors’ decisions. In this paper, we extend their work by proposing a new development, namely, emotional corporate finance. We argue that, just as investors may view investments as phantastic objects, managers may view their projects similarly. We develop a formal approach that considers the effects of managerial phantasy on the investment appraisal decision, project performance, and managerial entrapment in a losing project. Our main results are as follows: 1) managerial project-phantasy may induce a manager to mistakenly invest in value-reducing projects; b) phantasy may lead to volatility of managerial emotions, and hence volatility of project performance; c) phantasy may lead to project entrapment, but may result in project abandonment if the manager’s project-phantasy turns to project hatred. We conclude by considering whether managerial phantasy could explain management’s entrapment in the Concorde project.

BP's Failure to Debias: Underscoring the Importance of Behavioral Corporate Finance

This paper provides a behavioral analysis of BP, whose capital budgeting decisions in the last decade have resulted in a series of high-profile accidents, including the worst environmental disaster in US history. This analysis uses BP as a vehicle to discuss the application of business processes and psychological pitfalls to analyze corporate culture. The paper identifies weaknesses and vulnerabilities in BP's culture, makes comparisons with the corporate financial practices at other firms, and offers suggestions about how BP can engage in debiasing. Notably, the paper also suggests that insufficient knowledge of behavioral decision making resulted in analysts, investors, and regulators attaching insufficient emphasis to the risks in BP's operations. The paper calls for more attention to the psychological aspects of corporate behavior by analysts, regulators, corporate managers, and academics.

BP's Failure to Debias: Underscoring the Importance of Behavioral Corporate Finance

This paper provides a behavioral analysis of BP, whose capital budgeting decisions in the last decade have resulted in a series of high profile accidents, including the worst environmental disaster in U.S. history. The analysis uses BP as a vehicle to discuss the application of business processes and psychological pitfalls to analyze corporate culture. The paper identifies weaknesses and vulnerabilities in BP’s culture, makes comparisons with the corporate financial practices at other firms, and offers suggestions about how BP can engage in debiasing. Notably, the paper also suggests that insufficient knowledge of behavioral decision making resulted in analysts, investors, and regulators attaching insufficient emphasis to the risks in BP’s operations. The paper calls for more attention to the psychological aspects of corporate behavior by analysts, regulators, corporate managers, and academics.

Psychology and financial management: Behavioral corporate finance

In this paper, we present behavioral corporate finance. Unlike the dominant theory of modern corporate finance, behavioral corporate finance allows situations in which investors are not entirely rational. Behavioral corporate finance also allows corporate financial managers to have nonstandard preferences, to make biased decisions, and even, occasionally to be irrational. All those irrationalities might have a significant impact on the corporate objective function, corporate financial and investment policy as well as to system of corporate governance.

Behavioral Corporate Finance: An Updated Survey

We survey the theory and evidence of behavioral corporate finance, which generally takes one of two approaches. The market timing and catering approach views managerial financing and investment decisions as rational managerial responses to securities mispricing. The managerial biases approach studies the direct effects of managers’ biases and nonstandard preferences on their decisions. We review relevant psychology, economic theory and predictions, empirical challenges, empirical evidence, new directions such as behavioral signaling, and open questions.

Corporate Managers’ Risk Propensity

Traditionally, financialists have based their work on the standard assumption that agents are fully rational, self-interested, and maximisers of expected utility. However, researchers are increasingly recognizing that the psychological biases of managers may affect decision-making and outcomes in corporations. Behavioral Finance (BF) and Behavioral Corporate Finance (BCF) examine the effects of managerial and investor psychological biases on firm’s corporate finance decisions (such as investment appraisal and capital structure). This study investigates professional corporate managers’ behavior across decision settings. Specifically, manager’s decisions to take or avoid risk are investigated when evaluating data. The study also, examines the factors which may affect the manager’s tendency towards risk taking or avoiding. Therefore, the relation between Education, Specialist in Education, experience, capitals of the company, understanding financial concepts and the degree of risk aversion has been examined in different business sector in Jeddah area, KSA.

Behavioural corporate finance: existing research and future directions

Behavioural corporate finance (BCF) examines the effects of managerial and investor psychological biases on a firm's corporate finance decisions (such as investment appraisal and capital structure). In contrast to the well-developed research in behavioural finance (which examines the effects of investors' biases on the behaviour of the financial markets), the emerging research in BCF is relatively young. In this paper, we review the existing research to date in BCF and suggest areas for future development.

How Psychological Pitfalls Generated the Global Financial Crisis

The root cause of the financial crisis that erupted in 2008 is psychological. In the events which led up to the crisis, heuristics, biases, and framing effects strongly influenced the judgments and decisions of financial firms, rating agencies, elected officials, government regulators, and institutional investors. Among the many lessons to be learned from the crisis is the importance of focusing on the behavioral aspects of business process. Examples involving UBS, Merrill Lynch, Citigroup, Standard & Poor’s, and the SEC illustrate this point. The examples provide support for a position arguing behavioral finance needs to be much better integrated into business school education. The extent of process failure prior to the crisis suggests when it comes to integrative education, behavioral corporate finance is especially germane.

From Behavioural to Emotional Corporate Finance: A New Research Direction

Behavioural finance and behavioural corporate finance analyses the effects of psychological biases, heuristics, and emotions on investors’ and managers’ decision-making and performance. Taffler and Tuckett (2005) have introduced a major paradigm shift by introducing a new field of research, namely Emotional Finance. This ground-breaking approach employs Freud’s theory of phantastic objects to analyse the effect of unconscious, infantile, emotions on investors’ decisions. In this paper, we extend their work by proposing a new development, namely, emotional corporate finance. We argue that, just as investors may view investments as phantastic objects, managers may view their projects similarly. We develop a formal approach that considers the effects of managerial phantasy on the investment appraisal decision, project performance, and managerial entrapment in a losing project. Our main results are as follows: a) Managerial project-phantasy may induce a manager to mistakenly invest in value-reducing projects. b) Phantasy may lead to volatility of managerial emotions, and hence volatility of project performance. c) Phantasy may lead to project entrapment, but may result in project abandonment if the manager’s project-phantasy turns to project hatred. We conclude by considering whether managerial phantasy could explain management’s entrapment in the Concorde project.

Irrational executives and corporate governance

The top managers of companies have a great influence on the investment and financing policies of the companies that they lead. According to the economic principal-agent theory, rational managers look after their own interests, even if this is at the cost of shareholders and other stakeholders. Literature on corporate governance describes the workings and effectiveness of mechanisms to constrain these agency problems. However, recent studies on behavioural corporate finance show that managers do not always act rationally and that this irrationality can have a quantifiable negative value impact in strategic decisions. The central question to this paper is this: what influence can corporate governance have in reducing the negative effects of irrational behaviour in managers?

Behavioral Corporate Finance: A Survey

This is an in-depth review article on Behavioral Corporate Finance written in Russian. The review covers major concepts and models in Behavioral Corporate Finance as well as summarizes and discusses many empirical results found in the literature. The five chapters cover (1) capital structure, (2) IPOs, (3) buybacks, (4) debt, and (5) dividends.

Behavioural Corporate Finance: Existing Research and Future Directions

Behavioural Corporate Finance (BCF) examines the effects of managerial and investor psychological biases on a firm's corporate finance decisions (such as investment appraisal and capital structure). In contrast to the well-developed research in behavioural finance (which examines the effects of investors' biases on the behaviour of financial markets), the emerging research in BCF is relatively young. In this paper, we review the existing research to date in BCF, and suggest areas for future development.