Does CEO overconfidence help to explain merger decisions? Overconfident CEOs overestimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal overinvestment in their company and their press portrayal. We find that the odds of making an acquisition are 65 % higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (–90 basis points) is significantly more negative than for non-overconfident CEOs (–12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

We use price pressure resulting from purchases by mutual funds with large capital inflows to identify overvalued equity. This is a relatively exogenous overvaluation indicator as it is associated with who is buying – buyers with excess liquidity – rather than what is being purchased. We document substantial stock price impact associated with purchases by high-inflow mutual funds, and find the probability of an SEO, insider sales, and the probability of a stock-based acquisition increase significantly in the four quarters following the mutual fund buying pressure. These results provide new evidence that firm managers are able to identify and exploit overvalued equity.

We examine how insiders and firms trade when arbitrage is limited. When arbitrage is costly (proxied by high idiosyncratic risk), insiders and firms earn higher absolute returns on their trades (insider trading, share repurchases, and seasoned equity offerings) in the following year. Furthermore, they initiate their trades following greater past price movements in the preceding year. These results are not driven by information asymmetry or firm size. Overall, our results are consistent with the idea that insiders and firms compete with outside arbitrageurs in exploiting mispricings and benefit when outside arbitrage is limited.

We examine US local telephone markets shortly after the Telecommunications Act of 1996. The data suggest that older, experienced, educated managers tend to enter markets with fewer competitors. This motivates a structural econometric model based on behavioral game theory that allows heterogeneity in managers ’ ability to correctly conjecture competitor behavior. We find that manager characteristics are key determinants in managerial ability. Furthermore, our estimate of ability predicts out-of-sample success. Counterfactuals provide insight into the industry’s struggles despite substantial (indirect) subsidies: It is only when the ability to correctly conjecture competitor behavior is high that firms enter empty markets.

This paper provides a behavioral analysis of BP, whose capital budgeting decisions in the last decade have resulted in a series of high profile accidents, including the worst environmental disaster in U.S. history. The analysis uses BP as a vehicle to discuss the application of business processes and psychological pitfalls to analyze corporate culture. The paper identifies weaknesses and vulnerabilities in BP’s culture, makes comparisons with the corporate financial practices at other firms, and offers suggestions about how BP can engage in debiasing. Notably, the paper also suggests that insufficient knowledge of behavioral decision making resulted in analysts, investors, and regulators attaching insufficient emphasis to the risks in BP’s operations. The paper calls for more attention to the psychological aspects of corporate behavior by analysts, regulators, corporate managers, and academics. We thank Ellen Jones from UBS for helping us to gain access to UBS analyst reports, journal editor Fernando Zapatero for comments, Morgan Stanley energy analyst Yulia Reuter for discussions about risk

We outline a simple model in which optimizing firms choose corporate investment, external financing, and cash holding decisions simultaneously. The model generates predictions for the responsiveness of the above three corporate financial decisions to cash flow shocks and firm misvaluation, as well as new predictions for the crosseffects of misvaluation on the cash flow sensitivities of these corporate policy variables. We test all these predictions based on a large sample of public firms in the U.S. and find consistent evidence. Overall, by confirming the model‟s predictions for the signs of cash flow sensitivities, misvaluation sensitivities and cross-sensitivities for a number of different misvaluation measures, our model provides strong support for the notion that the wedge between the cost of external and internal finance affects corporate policies. Our estimation method follows Gatchev, Pulvino, and Tarhan (2010) in that we employ a dynamic simultaneous-equation model which is subject to the constraint that sources must equal uses of cash. However, contrary to Gatchev, Pulvino, and Tarhan‟s (2010) claims, we empirically show that this approach does not

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We show that characteristics of stock issuers can be used to forecast important common factors in stocks ’ returns such as those associated with book-to-market, size, and industry. Specifically, we use differences between the attributes of stock issuers and repurchasers to forecast characteristic-related factor returns. For example, we show that large firms underperform after years when issuing firms are large relative to repurchasing firms. While our strongest results are for portfolios based on bookto-market (i.e., HML), size (i.e., SMB), and industry, our approach is also useful for forecasting factor returns associated with distress, payout policy, and profitability. IT IS WELL KNOWN THAT FIRMS that issue stock subsequently earn low returns relative to other firms. Loughran and Ritter (1995) find that firms issuing equity in either an IPO or a SEO underperform significantly post-offering. Loughran and Vijh (1997) show that acquirers in stock-financed mergers later underperform. Conversely, Ikenberry, Lakonishok, and Vermaelen (1995) find that firms repurchasing shares have abnormally high returns. Fama and French (2008a)