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Impacts of Internal Financing on Investment Decisions by Optimistic and Overconfident Managers

Authors


  • The author would like to thank an anonymous referee and John Doukas (Managing Editor) for their useful comments and suggestions. The financial support in the form of Kagawa University Specially Promoted Research Fund 2010 and JSPS Grant-in-Aid for Scientific Research (No. 23730353) is gratefully acknowledged.

Abstract

The paper examines the interactions of investment decisions by managers who display optimistic and overconfident biases on the prospects of firm growth and riskiness with internal financing. The model demonstrates that the investment threshold for optimistic and overconfident managers can both rise above and fall below the threshold to maximize the market value of the firm, depending on the level of internal funds. It also derives the optimal level of internal funds that induces the managers to maximize the market value of the firm and illustrates the impacts of managerial optimism and overconfidence.

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