Investor Sentiments and Financial Decision Making in Pakistan

Contents

THESIS   PROPOSAL        

Introduction:        

Literature Review:        

INVESTMENT Decisions        

FINANCING Decisions:        

DIVIDEND Decisions:        

Research objective:        

Research questions:        

Methodology:        

Variables:        

Model:        

Research Structure:        

REFERENCES:        

                                              THESIS   PROPOSAL

TOPIC:

INVESTOR SENTIMENTS AND FINANCIAL DECISION MAKING IN   PAKISTAN

Introduction:

In classical finance theories, there is no existence of such investor beliefs. According to efficient market hypothesis (EMH), market is perfect. All new information is quickly incorporated into asset prices and no one can gain abnormal profits. IN classical theory it was showed that all investors are rational, free of sentiments (Chuangxia Huang et.al). But behavioral finance rejected the assumption of investor perfect rationality.

A person makes many decisions on the basis of his feelings and thoughts, so in every human decision there is existence of biasedness and errors of his judgments and on the basis of these feelings made beliefs. As one person having different beliefs that’s why shows different behavior and responds differently to same situation. It is called sentiments. Investors having some beliefs towards investment and due to these show optimistic and pessimistic behaviors towards investments that affect its value and returns. This is called investor sentiments. Investor’s decisions not only depend on their belief but also on the beliefs of other investors in the same market which is called relevant sentiments (Sergei Izmalkov and Muhamet Yildiz).

According to Baker and Wurgler, sentiments had stronger impact on stock value and its returns. Brown and Cliff found that even in short run sentiments not show significant effect but in long run they are negatively associated with earnings from investments. According to DSSW 1990,investor’s sentiments also having significant impact on asset prices.

These sentiments are actually future returns expectations (in form of dividends) from the investment they made. In response to these expectations firm make their financial decisions and vary financial decision policies in order to change the investor expectations. When investor is pessimistic having lower sentiments so under value firm and if having optimistic beliefs, high sentiments than over value firm ( NITTIA k. Bergman).

In financial decision making, firms make decision about investment, financing and dividend payout. This paper focuses on describing the effect of investor sentiments on firm financial decision making in context of Pakistan.

Literature Review:

In the past there are many researches which are conducted separately by considering investment , financing and dividend payout decision related to investor sentiments. We take a view of all those separately in this section.

 INVESTMENT Decisions:

Investor’s goal is the maximum estimation of expected return that is affected by investor sentiment. when investor sentiment is low enough, the investor should reject the investment, this condition leads the depression financial market to prevail, then the financial crisis erupts; when investor sentiment is modest, the financial crisis is difficult to erupt unless the decline of investor sentiment is quick and deep (Jun Xiea,* and Chunpeng Yangb).

Corporate investment level increases with investors’ optimism and that the relationship between investment level and executive compensation depends on investor sentiment and other parameters. The empirical test shows that optimism is significantly and positively related to the level of investment and that executive compensation is insignificantly related to the level of investment (Bruce D. Grundy a, Hui Li ).

The so-called “investor sentiment” not only plays a key role on investment decisions of the investors, but also affects the investment of listed firms in the capital market. In details, many scholars have found that the investor sentiment can influence the stock price and then vary the financing situation of a company. If the company has no financing constraints, rational managers would issue stocks or repurchase corporate shares. Therefore, from this viewpoint, both the investment time and investment cost have a strong relationship with the investor sentiment. Moreover, investor sentiment can affect the investment of a company directly without equity issuance or repurchase. The corporate management could cater to investor sentiment, and increase investment when the investor sentiment is excited; while they could decrease investment and give up some undervalued projects with positive net present value to cater to the pessimistic investor sentiment (Zhao-Hui Zhu,  Zheng-Cheng Zhao ,Han-Tao Bao).

The three major decisions in corporate finance involve investment, financing, and working capital management. Wise investment decisions, such as projects with positive net present value (NPV), may increase the firm value. However, managers often tend to invest either less than or more than the optimal level; these phenomena are called, respectively, underinvestment and overinvestment. when firms have good investment opportunities, managerial optimism increases overinvestment. Conversely, if firms have poor investment opportunities, managerial pessimism increases underinvestment (Hsiao-Fen Hsiao, Chuan-Ying Hsu, Chun-An Li, and Ai-Chi Hsu).

FINANCING Decisions:

In a world of imperfect capital markets, financing and investment decisions are not independent. For example, internal cash flow may influence the investment policy under the consideration of financial constraints (Fazzari et al. 1988; Kaplan and Zingales 1997). The mechanism of corporate governance also affects the sensitivity between investment and cash flow (Almeida and Campello 2001; Hsu et al. 2009).

According to the neoclassical view, the market is efficient and all movements in stock prices rationally reflect changes either in expected future cash flows or in proper discount rates. Thus, if prices are high, firms might want to issue more equity because the flexibility inherent in a less leveraged capital structure is especially appealing when a large number of positive NPV projects are available. And, similarly, mergers might be more valuable in such periods, because it becomes all the more important to re- allocate capital to the highest-value users (Boyan Jovanovic and Peter L. Rouss).