Ch. 4: Behavioral Corporate Finance 177
career concerns, e.g., a situation where the manager tries to distort the updating process
to maintain high compensation.Shefrin (2001)offers several anecdotes concerning ma-
jor corporate investments that have the flavor of good money after bad, andStatman
and Sepe (1989)find that the market reaction to the termination of historically unprof-
itable investment projects is positive, suggesting that investors recognize that executives
have a tendency to continue poor projects. Related evidence comes from theGuedj
and Scharfstein (2004)study of drug development decisions. Those authors find that
single-product early stage firms appear highly reluctant to abandon their only viable
drug candidates, even when the results of clinical trials are less than promising. Some
combination of agency, managerial optimism, and a gambling-to-get-back-to-even atti-
tude seems like a plausible explanation for these results.
- Conclusion
The behavioral corporate finance literature has matured to the point where one can
now sketch out a handful of canonical theoretical frameworks and use them to orga-
nize the accumulated evidence of dozens of empirical studies. This survey suggests that
the behavioral approaches to corporate finance offer a useful complement to the other
paradigms in the field. They deliver intuitive and sometimes quite compelling explana-
tions for important financing and investing patterns, including some that are difficult to
reconcile with existing theory.
In its current state of flux, the field offers a number of exciting research questions.
We close by highlighting just a few. In no particular order, we wonder:
- Are behavioral factors at the root of why managers do not more aggressively pursue
the tax benefits of debt, as inGraham (2000)? Hackbarth (2004)develops a theoretical
argument along these lines. - While the existing literature has generally considered the two approaches separately,
the irrational manager and irrational investor stories can certainly coexist. Would a
model featuring a correlation between investor and managerial sentiment, for exam-
ple, lead to new insights? - What are the determinants of managerial “horizons”, and how can they be measured
and appropriately governed?Polk and Sapienza (2004)andGaspar, Massa, and Matos
(2005)use share turnover by investors to proxy for shareholder horizons. - To what extent should the venture capital industry be viewed as an institution that
identifies and caters to emerging pockets of investor sentiment? - What determines investor sentiment, and how is it managed through corporate in-
vestor relations? Potential avenues to consider are interactions with past stock market
returns, technological change and the valuation of new industries, media cover-
age, financial analysts and financial reporting, or investment banking.Brennan and
Tamarowski (2000)offer an overview of investor relations. - Do equity and debt market timing reduce the overall cost of capital by a large amount,
or just a little?Dichev (2004)offers an approach here.