Chapter 1 - Behavioral Foundations
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2
Introduction: course
• Course outline
– Identify key psychological obstacles to value maximizing behavior, along with steps that managers can take to mitigate the effects of these obstacles. – Valuations, capital budgeting, risk and return, EMH, capital structure, dividend policy, agency problems, and M&As
• Behavioral treatment
– Traditional material help managers to achieve valuemaximizing decisions – However, behavioral pitfalls hamper in applying these technique correctly
15
Sample size neglect: example
• A certain town is served by two hospitals. In the larger hospital, 45 babies are born each day whereas only 15 babies are born in the smaller hospital. 50% of all babies are boys, but the exact percentage varies from day to day. • For a period of 1 year, each hospital recorded the days on which more than 60% of the babies born were boys. Which hospital do you think recorded more such days?
13
Base-rate neglect cont’d
• Description: Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. • Which statement is more likely to be true?
全文阅读已结束如果下载本文需要使用
Behavioral Corporate Finance 2011 Spring
School of Management Xiamen University
Introduction: myself
• Zhe Shen
– PhD (Fin), MSc (Acc & Fin Econ) and BSc (Acc) – Research interests: Corporate Finance, Behavioral Finance, … – Joined the XMU in 2007 – Email: z.shen@ – Tel.: 0592 2187352 – Office: Room 511-4, Baoxinliyng Building
9
Traditional and behavioral
• Traditional treatment
– Financing Investment Payout – Maximizing shareholder wealth NPV(DCF) discount rate to adjust risks – Conflicts of interest between managers and investors
12
Base-rate neglect
• A cab was involved in a hit and run accident at night. There are two cab companies that operate in the city, a Blue Cab company, and a Green Cab Company. You are given the following data: – 85% of the cabs in the city are Green and 15% are Blue. – A witness at the scene identified the cab involved in the accident as a Blue Cab. – This witness was tested under similar visibility conditions and made correct color identifications in 80% of the trial instances. • What is the probability that the cab involved in the accident was a Blue Cab rather than a Green one?
A: Linda is a bank teller B: Linda is a bank teller and active in the feminist movement
14
BTW: base-rate overweighting
• Representativeness heuristic can result in neglect of relevant base rates while conservatism heuristic can lead to overweighting of a certain base rates. • Example: there are two urns, one containing 3 blue balls and 7 red ones, and the other containing 7 blue balls and 3 red ones. A random draw of 12 balls, with replacement, from one of the urns yields 8 reds and 4 blues. • What is the probability the draw was made from the first urn?
7
Belief/preference or judgement/decision
News
Posterior belief Prior belief Individual choice Preference Price
8
Outline
• Traditional and behavioral treatment of corporate financial decision • Behavioral pitfalls – beliefs • Behavioral pitfalls – preferences • Illustrative example: Scott McNealy and Sun
5
Chapter 1 Behavioral Foundats
• To demonstrate that there are several psychological phenomena that can cause corporate managers to commit expensive mistakes when making decisions
– Beliefs/preferences (my version) – Heuristics and biases/framing effects (textbook version)
• Students are expected to
– Identify the key biases that lead managers to faulty financial decisions about risk alternatives – Explain why reliance on heuristics and susceptibility to framing effects render managers vulnerable to making faulty decisions that reduce firm value – Recognize that investors are subject to the same biases
10
Behavioral pitfalls I: beliefs
• Heuristics
– Representativesness – Availability – Anchoring
• • • •
Overconfidence Excessive optimism Self attribution Illusion of control
• Assessment
– 20% class participation – 30% quiz – 50% final examination
4
Proposed schedule
• • • • • • • • Week 1: Introduction and behavioral foundations Week 2: Valuation Week 3: Capital budgeting Week 4: Perceptions about risk and return Week 5: Inefficient markets and corporate decisions Week 6: Capital structure Week 7: Dividend policy Week 8: Mergers and Acquisitions
11
Representativeness
• Representative heuristic is a rule of thumb wherein people tend to judge the probability or frequency of a hypothesis by considering how much the hypothesis resembles available data • Example: all families of six children in a city were surveyed. In 72 families, the exact order of births of boys and girls was GBGBBG. • What is your estimate of the number of families surveyed in which the exact order of births was BGBBBB
• Learning outcome/goal
– To help students learn how to put the traditional tools of corporate finance to their best use – To mitigate the effects of psychological obstacles that reduce value
3
Introduction: course cont’d
• Textbook
– Hersh Shefrin, Behavioral Corporate Finance, 1/e, McGraw Hill, 2007
• Lecture schedule
– Tuesday (3,4) and Thursday (1,2)
Introduction: course
• Course outline
– Identify key psychological obstacles to value maximizing behavior, along with steps that managers can take to mitigate the effects of these obstacles. – Valuations, capital budgeting, risk and return, EMH, capital structure, dividend policy, agency problems, and M&As
• Behavioral treatment
– Traditional material help managers to achieve valuemaximizing decisions – However, behavioral pitfalls hamper in applying these technique correctly
15
Sample size neglect: example
• A certain town is served by two hospitals. In the larger hospital, 45 babies are born each day whereas only 15 babies are born in the smaller hospital. 50% of all babies are boys, but the exact percentage varies from day to day. • For a period of 1 year, each hospital recorded the days on which more than 60% of the babies born were boys. Which hospital do you think recorded more such days?
13
Base-rate neglect cont’d
• Description: Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. • Which statement is more likely to be true?
全文阅读已结束如果下载本文需要使用
Behavioral Corporate Finance 2011 Spring
School of Management Xiamen University
Introduction: myself
• Zhe Shen
– PhD (Fin), MSc (Acc & Fin Econ) and BSc (Acc) – Research interests: Corporate Finance, Behavioral Finance, … – Joined the XMU in 2007 – Email: z.shen@ – Tel.: 0592 2187352 – Office: Room 511-4, Baoxinliyng Building
9
Traditional and behavioral
• Traditional treatment
– Financing Investment Payout – Maximizing shareholder wealth NPV(DCF) discount rate to adjust risks – Conflicts of interest between managers and investors
12
Base-rate neglect
• A cab was involved in a hit and run accident at night. There are two cab companies that operate in the city, a Blue Cab company, and a Green Cab Company. You are given the following data: – 85% of the cabs in the city are Green and 15% are Blue. – A witness at the scene identified the cab involved in the accident as a Blue Cab. – This witness was tested under similar visibility conditions and made correct color identifications in 80% of the trial instances. • What is the probability that the cab involved in the accident was a Blue Cab rather than a Green one?
A: Linda is a bank teller B: Linda is a bank teller and active in the feminist movement
14
BTW: base-rate overweighting
• Representativeness heuristic can result in neglect of relevant base rates while conservatism heuristic can lead to overweighting of a certain base rates. • Example: there are two urns, one containing 3 blue balls and 7 red ones, and the other containing 7 blue balls and 3 red ones. A random draw of 12 balls, with replacement, from one of the urns yields 8 reds and 4 blues. • What is the probability the draw was made from the first urn?
7
Belief/preference or judgement/decision
News
Posterior belief Prior belief Individual choice Preference Price
8
Outline
• Traditional and behavioral treatment of corporate financial decision • Behavioral pitfalls – beliefs • Behavioral pitfalls – preferences • Illustrative example: Scott McNealy and Sun
5
Chapter 1 Behavioral Foundats
• To demonstrate that there are several psychological phenomena that can cause corporate managers to commit expensive mistakes when making decisions
– Beliefs/preferences (my version) – Heuristics and biases/framing effects (textbook version)
• Students are expected to
– Identify the key biases that lead managers to faulty financial decisions about risk alternatives – Explain why reliance on heuristics and susceptibility to framing effects render managers vulnerable to making faulty decisions that reduce firm value – Recognize that investors are subject to the same biases
10
Behavioral pitfalls I: beliefs
• Heuristics
– Representativesness – Availability – Anchoring
• • • •
Overconfidence Excessive optimism Self attribution Illusion of control
• Assessment
– 20% class participation – 30% quiz – 50% final examination
4
Proposed schedule
• • • • • • • • Week 1: Introduction and behavioral foundations Week 2: Valuation Week 3: Capital budgeting Week 4: Perceptions about risk and return Week 5: Inefficient markets and corporate decisions Week 6: Capital structure Week 7: Dividend policy Week 8: Mergers and Acquisitions
11
Representativeness
• Representative heuristic is a rule of thumb wherein people tend to judge the probability or frequency of a hypothesis by considering how much the hypothesis resembles available data • Example: all families of six children in a city were surveyed. In 72 families, the exact order of births of boys and girls was GBGBBG. • What is your estimate of the number of families surveyed in which the exact order of births was BGBBBB
• Learning outcome/goal
– To help students learn how to put the traditional tools of corporate finance to their best use – To mitigate the effects of psychological obstacles that reduce value
3
Introduction: course cont’d
• Textbook
– Hersh Shefrin, Behavioral Corporate Finance, 1/e, McGraw Hill, 2007
• Lecture schedule
– Tuesday (3,4) and Thursday (1,2)