Author(s)

Zhigang Liu¹, Congming Mu¹, Chunhui Wen^1,2

¹School of Finance, Shanghai University of Finance and Economics, Shanghai, China.
²School of Economics, Hunan Agricultural University, Changsha, China.

This paper extends the standard model of real option by allowing managerial biases originating from the cognition about the economic states in the future to examine the impacts of internal liquid funds on the firm’s investment decisions. The model indicates that the interactions between the cognition biases and firm’s volatility determine the extent to which the manager overestimates the growth rate, hence subjectively overvalues the firm’s value and distorts the investment decisions. The managerial cognition biases enhance the sensitivity of corporate investment to cash flow and increase the convexity of the investment decisions against the firm’s volatility. Relying on the amount of internal liquidity, the manager with cognition biases can both delay and expedite investing.

Cognition Biases, Internal Financing, Real Option, Investment, Behavioral Finance, Subjective Evaluation

Liu, Z. , Mu, C. and Wen, C. (2016) Impacts of Internal Financing on Investment Decisions by Managers with Cognition Biases. Journal of Mathematical Finance, 6, 431-442. doi: 10.4236/jmf.2016.63034.