Capital Structure - Hersh Shefrin Behavioral Corporate Finance

7 important questions on Capital Structure - Hersh Shefrin Behavioral Corporate Finance

Adjusted Present Value (APV) is

The sum of net present value (NPV) and the value of associated financing side effects.

When will financial executives tend to repurchase shares?

When stock is underpriced.

How would managers choose between using the firm's cash to repurchase shares and using the firm's cash to finance a new project?

Base the choice on APV
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Sensitivity of investment to cash flow

the tendency for investment policy to depend on how much cash a firm holds. The evidence is strong that when firms receive more cash or take on less debt, they invest more.

What are the most pervasive (doordringend) biases afflicting managers?

Excessive optimism and overconfidence. The combination of these two leads the managers of cash-rich firms to undertake negative NPV projects. These firms will over invest. The net result is that excessively optimistic, overconfident managers misjudge APV to be negative when it is positive. As a result, they reject some positive NPV projects when they are cash-poor and have limited debt capacity. 

What are the two main indications that a CEO is excessively optimistic and overconfident?

The first is press coverage. The second indicator is that CEOs hold their executive stock options until they are close to expiration.

What are the two main reasons for lack of diversification in CEO portfolios?

  1. CEO compensation contracts regularly contain large quantities of stock and option grants in lieu (i.p.v.) of cash compensation. To maximise the incentive effects of these holdings, boards prohibit their CEO's from perfectly hedging agains the risk by selling company stock short. 
  2. The CEO's repetitional capital is invested in the firm, so a bad outcome in her firm will not only negatively impact her personal portfolio but will also reduce her outside opportunities.

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