From Behavioural to Emotional Corporate Finance: A New Research Direction

25 Pages Posted: 16 Sep 2009

See all articles by Richard J. Fairchild

Richard J. Fairchild

University of Bath - School of Management

Date Written: September 15, 2009

Abstract

Behavioural finance and behavioural corporate finance analyses the effects of psychological biases, heuristics, and emotions on investors’ and managers’ decision-making and performance. Taffler and Tuckett (2005) have introduced a major paradigm shift by introducing a new field of research, namely Emotional Finance. This ground-breaking approach employs Freud’s theory of phantastic objects to analyse the effect of unconscious, infantile, emotions on investors’ decisions. In this paper, we extend their work by proposing a new development, namely, emotional corporate finance. We argue that, just as investors may view investments as phantastic objects, managers may view their projects similarly. We develop a formal approach that considers the effects of managerial phantasy on the investment appraisal decision, project performance, and managerial entrapment in a losing project. Our main results are as follows: a) Managerial project-phantasy may induce a manager to mistakenly invest in value-reducing projects. b) Phantasy may lead to volatility of managerial emotions, and hence volatility of project performance. c) Phantasy may lead to project entrapment, but may result in project abandonment if the manager’s project-phantasy turns to project hatred. We conclude by considering whether managerial phantasy could explain management’s entrapment in the Concorde project.

Keywords: behavioural corporate finance, emotional corporate finance, phantasy, emotional volatility, investment appraisal, project entrapment

JEL Classification: G31

Suggested Citation

Fairchild, Richard J., From Behavioural to Emotional Corporate Finance: A New Research Direction (September 15, 2009). Available at SSRN: https://ssrn.com/abstract=1473742 or http://dx.doi.org/10.2139/ssrn.1473742

Richard J. Fairchild (Contact Author)

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom
01225 323456 (Phone)
01225 323902 (Fax)

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