Behavioural Corporate Finance

Question 1

What does the Heuristic model suggest?

Answer 1

Managers are conflicted-should they think about short or long run? Should they look out for themselves or shareholders? Should they maximise intrinsic value or cater to irrational investors?
They usually maximise price not value (cater to themselves or shareholders)

Question 2

How would managers cater to investors? 3

Answer 2

• change company name:names attract customers and investors (dot com bubble)
• dividends demands: investors want constant dividend streams
• if shaders are overpriced, they issue more and then use them to buy other companies

Question 3

What happens when companies have spare cash?

Answer 3

They can increase dividends, invest in projects or buy back shares.

They usually tend to over invest in projects and buy back shares. Don’t usually increase dividend.

People also usually over acquire and then don’t know what to do with the acquired companies

Question 4

What are the key points of rational managers and irrational investors? 3

Answer 4

• rational managers try to make use of mispricing
• they mainly focus on the short term (but don’t ignore the long term)
• catering:management take actions designed to appeal to investors

Question 5

Why would managers be loss averse?

Answer 5

Managers will take reps to avoids closing an account or booking a loss because their job depends on their project. People care about sunk costs because their job depends on it, so they pour more money into it to avoid a loss. (Quite rational)

Question 6

Why is restructuring needed in a firm?

Answer 6

Because the new managers have no ownership of old projects so they can say or do things the existing managers couldn’t (like closing bad projects)

Question 7

There is a lot of evidence that managers are over confident. Is this a good thing?

Answer 7

Overconfidence is a good trait because all managers and CEO’s have confidence in their own abilities. You get a lot of awards but not much punishment. Overconfidence is self reinforcing-people hire overconfident people

-it is used to convince people

Question 8

What are the assumptions of rational and irrational managers? 4

Answer 8

• irrational investors impact share prices because of limits to arbitrage (if there weren’t limits there would be no mispricing)
• managers have the ability finally when their share price is mid valued and use it to their benefit
• managers should have an info advantage over investors given their insider status
• managers are less constrained than investors (if a share price is overvalued managers can sell more shares, but investors would need to short sell-constraints to short selling)