Biased beliefs, costly external finance, and firm behavior : A Unified theory

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Title: Biased beliefs, costly external finance, and firm behavior : A Unified theory
ISBN: 978-952-323-293-8
Author: Li, Delong ; Lu, Lei ; Mu, Congming ; Yang, Jinqiang
Organization: Bank of Finland
Series: Bank of Finland Research Discussion Papers
ISSN: 1456-6184
Series year: 2019
Series number: 18/2019
Year of publication: 2019
Publication date: 9.9.2019
Pages: 48
Subject (yso): rahoitus; yritykset; johtajat; investoinnit
Keywords: ulkoinen rahoitus; rationaalisuus
JEL: E32; G31; G32; G35; G41
Other keywords: costly external finance; investment; liquidity management; overconfidence; overextrapolation; payout
Abstract: Overconfidence and overextrapolation are two behavioral biases that are pervasive in human thinking. A long line of research documents that such biases influence business decisions by distorting managers' expected productivity. We propose a new mechanism in which the biases change firms' precautionary motives when external financing is costly, finding that the influences of biases on investment, payouts, and refinancing are stronger for financially weaker firms. Moreover, biased and rational firms display di erential responses to economic booms and busts holding financial positions constant. Our work illustrates that managerial traits, when interacting with imperfect capital markets, drive firm dynamics in business cycles.

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