This research investigated the potential effects of managerial overconfidence and
regret aversion in a corporate capital investment context. Three fundamental decision
problems are analysed: Project selection (accepting or rejecting a proposed
investment), managerial effort, and project evaluation (continuing or abandoning a
failing investment). Very little previous research has looked at the role of
psychological biases in corporate finance decisions, and the joint analysis of the two
studied biases within one model is also a fairly novel contribution.
Solving by backward induction a theoretically derived model integrating these
decisions as well as overconfidence and regret aversion, I outline the conditions under
which a biased manager will make choices that are inefficient from a shareholder value
perspective; however, the model also reveals that, in combination, the two
psychological phenomena may off-set such that the optimal outcome can be obtained.
I further demonstrate how my theoretical propositions can be supplemented with
empirical data by means of a survey and two different experiments. The survey of UK
managers with capital investment responsibility exposes the pervasiveness of
overconfidence and regret aversion within the sample group. In addition, indications
for potential associations between these biases and certain capital investment decision
choices are found. To my knowledge, no such empirical study exists so far.
To explore potential causal relationships between overconfidence and effort,
overconfidence and project selection, as well as regret aversion and project evaluation
choices, two experiments were designed and conducted. The experimental data
provides tentative support for the model and indicates the potential value of largerscale
I close by discussing the implications of my results for corporate governance and
suggesting avenues for future work in this area.
|Date of Award||1 May 2006|
|Supervisor||Richard Fairchild (Supervisor) & Peter Vass (Supervisor)|