Focal points and firm risk

Ye Cai and Hersh Shefrin

European Financial Management, 2018, vol. 24, issue 4, 521-544

Abstract: The ‘better than average’ effect suggests that relative industry standing should serve as an important focal point for corporate managers. March and Shapira (Psychological Review, 99, 172–183, 1992) develop a framework to analyze the impact of focal points on firms’ risk profiles. This paper uses the March–Shapira model to investigate the relationship between firms’ relative industry standings and their risk profiles. We find that firms’ equity returns display strong March–Shapira effects. When we examine the different firm decisions that impact risk, we find the strong presence of March–Shapira effects in firms’ decisions about operating cash flows, diversifying acquisition activity, working capital, and capital structure.

Date: 2018
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