What Is Behavioral Corporate Finance?

Behavioral corporate finance is the study of how owners and managers of publicly-traded companies make decisions that affect the values of those companies. It offers a way to understand how decisions are made in corporate finance, reflecting the reality that markets are not always efficient. As a result, the people who run these firms may make decisions that are equally inefficient in terms of the long-term value of the company. Those who study behavioral corporate finance understand that firm managers may make decisions based not on what might be in the best interest of their firms, but based instead on their own personal styles and strategic beliefs.

At a time when the transparency of corporate culture is of paramount importance to investors, it is crucial to understand the reasons for decisions made by corporate heads and chief executive officers. These individuals are often expected to raise the values of the companies they run in terms of stock prices. How they go about reaching those goals can vary widely from company to company and from executive to executive. Behavioral corporate finance represents an effort to understand this decision-making process.

Central to the theory of behavioral corporate finance is the understanding that markets do not always behave efficiently. In other words, a company's stock price does not always reflect its long-term value. As a matter of fact, sometimes prices don't even match the current value of the company. Company executives must be ready to accept this reality so that their decisions aren't short-sighted.

For example, an executive making decisions like leveraging the company's assets or issuing more shares of stock in an effort to raise share price must realize that those decisions may have short-term effects that don't match up with the long-term ramifications. Such actions may create an immediate, positive reaction from investors while putting the company's future in jeopardy. Behavioral corporate finance posits that the never-ending quest for higher share prices, which often trigger stock options for the executives who achieve them, may not be in a company's best overall interests.

It is also a contention of the proponents of behavioral corporate finance that the actions of executives are often based more on personal biases than the best interests of the company. In other words, executives that tend to be aggressive with their own investments will likely do the same with the assets of the companies they run. Those who are conservative in nature will likely act the same on behalf of their companies.