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• 2 Lecture 2: behavioral finance and MenA

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• Corporate finance?behavioral financewhat are the two approaches of behavioral finance?

  Corporate finance aims to explain financial contracts and real investment decisions of companies. It studies especially agency problems arising from the separation of ownership and control between shareholders and managers.
  
  Behavioral corporate finance focuses on the beliefs and preferences of these two sets of agents.
  
  Two approaches of behavioral corporate finance:
  1 Some investors are less than fully rational.
  2 Managers can be less than fully rational.

• Irrational investors approach. the last one is managers balance between three objectives, what are they?

  1 Limits to arbitrage - prices can differ from fundamental values.
  
  2 Investors can influence security prices.
  
  3 Rational managers can identify mispricings and try to exploit them.
  Superior information. Fewer constrains than money managers. Experience, knowledge and ability to manufacture information advantage.
  
  4 Managers balance between three objectives:
  Maximizing fundamental value.
  Catering to irrational short-term investor demands. Exploiting the mispricing by market timing.

• Irrational managers approach.This approach studies managerial behavior that departs from rational expectations and expected utility maximization, but the manager continues to believe that he is maximizing firm value.   what are the two building block from the irrational managers approach?

  1 Rational investors, but with limited governance mechanisms.
  
  2 Main biases: optimism and overconfidence

• name 3 applications of behavioral corporate finance

  1 Investment policy: - Real investments. - Mergers and acquisitions.
  
  2 Financial policy: - Equity issues (IPOs, SEOs). - Share repurchases. - Debt issues.
  
  3 Other corporate decisions: - Earnings management. - Firm names

• Problem of behavioral corporate financeThe two approaches give opposite normative implications:

  1 Irrational investors approach recommends isolating managers from short-term share price pressures.
  
  2 Irrational managers approach recommends reducing discretion and obligating managers to respond to market price signals.

• Hubris explanation. what are the three building block for the hubris hypothesis.

  1 Why are there so many acquisitions, when there is little evidence that they create value for the acquirer, on average?
  
  2 Rational investors and efficient markets.
  
  3 Irrational managers approach: - Overconfidence and illusion of control. - Takeover is an individual decision. - Inexperience: average managers makes only a few takeover decisions

• Hubris explanation of M&A activity

  M&A decision is based on a valuation of an asset that has an already observable market price.
  
  The valuation can be considered as random variable. Offer is made when the valuation (random variable) exceeds the market price.
  
  The takeover premium is a random error and that represent a transfer form acquirer shareholders to target shareholders.
  
  The combined value of the target and bidder firms falls slightly due to wasted resources on unproductive activity.

• Malmendier and Tate (2006): Test of hubris hypothesis. name 3 results.relate optimism and mergers

  - Optimistic CEOs complete more mergers, especially diversifying mergers.
  - Optimism has its biggest effect among the least equity dependent firms.
  - Investors are more skeptical about offers made by optimistic CEOs.

• Schneider and Spalt (2006): Test of hubris hypothesis. ceo are more prone to gamble because acquirer announcement returns are smaller when? name 5 reasons why they gamble , because the acquirer announcement return is smaller.

  
  -If the CEO is more entrenched.
  - If the CEO is younger or more prone to gambling.
  - If the firm has performed poorly over the last 12 months.
  - If the difference of the current stock price to the 52-week high is large.
  -If the firm has reported negative earnings at the last fiscal year end.

• Rhodes-Kropf, Robinson and Viswanathan (2005). What 3 research question do they research?

  
  1. Study the effect of misvaluation on merger activity: periods of high M/B ratios coincide with periods of intense merger activity.
  
  2. Market-timing theories can explain the incentives of acquirers. 
  
  3 Why targets accept overvalued stock as an acquisition currency?