Handbook of Corporate Finance Empirical Corporate Finance Volume 1

146 M. Baker et al.

2.5. Other corporate decisions 164

2.5.1. Dividends 165

2.5.2. Firm names 166

2.5.3. Earnings management 167

2.5.4. Executive compensation 167

3. The irrational managers approach 168
   3.1. Theoretical framework 169
   3.2. Empirical challenges 171
   3.3. Investment policy 172
   3.3.1. Real investment 172
   3.3.2. Mergers and acquisitions 173
   3.4. Financial policy 174
   3.4.1. Capital structure 174
   3.4.2. Financial contracting 174
   3.5. Other behavioral patterns 175
   3.5.1. Bounded rationality 175
   3.5.2. Reference-point preferences 176


4. Conclusion 177
   References 178

Abstract

Research in behavioral corporate finance takes two distinct approaches. The first em-
phasizes that investors are less than fully rational. It views managerial financing and
investment decisions as rational responses to securities market mispricing. The second
approach emphasizes that managers are less than fully rational. It studies the effect
of nonstandard preferences and judgmental biases on managerial decisions. This sur-
vey reviews the theory, empirical challenges, and current evidence pertaining to each
approach. Overall, the behavioral approaches help to explain a number of important
financing and investment patterns. The survey closes with a list of open questions.

Keywords

irrational investors, irrational managers, investment policy, financial policy, market
timing, catering