A Behavioral Finance Approach to Working Capital Management in Context of Pakistani Firms

Abstract

Behavioral finance incorporates cognitive psychology into conventional finance, suggesting that people are prone to various heuristic driven biases in the decision-making process. Nevertheless, the literature on behavioral finance and working capital is rather thin, as studies of working capital tend to focus on either its determinants or its relation with profitability. We aim to bridge this substantial gap by exploring the influence of different behavioral biases including self-serving biases, level of confidence and loss aversion bias and representativeness bias altogether with different components of working capital management individually, which include cash management, inventory management, account receivables management, account payables (debt) management and risk management. The data collection from 97 finance professionals through a self-structured questionnaire comprising 32 questions on a Likert scale. The data analysis is through Smart PLS. The result indicated that behavioral biases exert a direct influence on all Working capital parameters but a weak relationship for account payables in the context of Pakistan’s services and manufacturing companies.

Keywords: working capital management, behavioral Bias, self-serving biases, level of confidence, loss aversion bias, representativeness bias