Effects of Availability bias on Corporate Borrowing: A Behavioral Perspective

Abstract

This article integrates an earning-based capital structure model into a simple real options framework to analyze the effects of availability heuristic and optimistic bias on the interaction between financing and investment decisions. Several empirical implications follow from solving the model. Notable, my analysis reveals that availability heuristic can ameliorate bondholder-shareholder conflicts, such as the debt overhang problem.

Furthermore, this paper discovers the effects of availability heuristic on optimistic and pessimistic managers. Optimistic Managers tend to have aggressive approach on investment decisions and accept risky projects. The optimistic manager will underperform on the long run. On the other hand, pessimistic managers tend to have conservative approach and avoid risky projects. Ultimately losing opportunities that are needed for the company’s development.