Managerial Optimism and Corporate Finance

Two dominant features emerge from a simple model of corporate finance with excessively managers and efficient capital markets. First, 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, 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 establish an underinvestmentoverinvestment tradeoff related to free cash flow without invoking asymmetric information or rational agency costs. In this paper, I explore the implications of a single specification of managerial irrationality in a…