Managerial Optimism and Corporate Finance

Financial Management, Summer 2002

14 Pages Posted: 25 Apr 2002 Last revised: 18 Feb 2019

Date Written: 2002


Two dominant features emerge from a simple model of corporate finance with excessively optimistic managers and efficient capital markets. First, optimistic managers believe that capital markets undervalue their firm's risky securities, and may decline positive net present value projects that must be financed externally. Second, optimistic managers overvalue their own corporate projects, and may wish to invest in negative net present value projects even when they are loyal to shareholders. These results imply an underinvestment-overinvestment tradeoff related to free cash flow, without invoking asymmetric information or rational agency costs.

Keywords: Behavioral Finance, Corporate Finance, Agency Costs, Asymmetric Information, Underinvestment, Overinvestment, Free Cash Flow

JEL Classification: G30, G31, G32, G34

Suggested Citation

Heaton, J.B., Managerial Optimism and Corporate Finance (2002). Financial Management, Summer 2002, Available at SSRN:

J.B. Heaton (Contact Author)

One Hat Research LLC ( email )

20 West Kinzie
17th Floor
Chicago, IL 60654
United States

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