Managerial Optimism: New Observations on the Unifying Theory

18 Pages Posted: 19 May 2020

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Date Written: November 2019

Abstract

Managerial optimism theory is behavioral finance's greatest achievement. It explains two prominent features of corporate financial behavior – over‐investment and pecking‐order capital structure preferences – that otherwise require two different theories with mutually incompatible assumptions about managerial loyalties to shareholder‐value maximization. After reviewing the development of managerial optimism as a unifying theory, I use a simple change of measure to transform risk‐averse optimism to risk‐neutral probabilities that can be pessimistic or optimistic depending on wealth changes. This unexplored feature has implications for, among other things, pay for performance when managers are excessively optimistic.

Keywords: agency cost theory, asymmetric information theory, behavioral corporate finance, managerial optimism, pay for performance

Suggested Citation

Heaton, J.B., Managerial Optimism: New Observations on the Unifying Theory (November 2019). European Financial Management, Vol. 25, Issue 5, pp. 1150-1167, 2019, Available at SSRN: https://ssrn.com/abstract=3600291 or http://dx.doi.org/10.1111/eufm.12218

J.B. Heaton (Contact Author)

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