Behavioral Corporate Finance

Summary Report on Case " Behavioral Corporate Finance"

Group 2

Members:

Neeraj Saxena

Amit Jain

C V Pani

Introduction

When thinking about a firm's financing and investment decisions, rational executives are guided by a belief in the efficiency of markets. But what if markets aren't always as efficient as we believe they are? And what if executives themselves are not rational and their decisions are biased in some predictable way? Or may be the case with investors also. These leads to two assumptions:

1. Investors are less than fully Rational

2. Managers are less than fully Rational.

Whole papers revolve around these two assumptions, with respective to investors and managers and various ways of investing and raising and utilizing the funds by managers.

Irrational Investors Approach:

In case of irrational investors approach, managers balances 3 conflicting goals:

a. Maximize the fundamental value: managers have more information and they would like to create value to the business with this information.

b. Maximize the current share price: managers in order to gain faith of short term investors try to increase the current returns on share prices. In this way managers try to influence temporary mispricing. For example changing the name of the corporation, or initiating the dividend.

c. Market timing: Managers try to exploit the mispricing for the benefits of existing shareholders with market timing. Managers by suppling the securities that are temporarily overvalued and repurchasing that are undervalued.

Managers sell less stock/equity when they care about short run stock price. By announcing the dividend policy they try to effect the fundamental values of the corporation.

Ex-Ante Misevaluation: this is the effect of market to book ratio, when this ratio is high, investors think that