The Influence of Cognitive Bias of the Managers in the Selection and use of Capital Budgeting Techniques: Evidence of Sri Lanka

Abstract

This study examines the influence of cognitive bias of the managers in the selection and usage practice of capital budgeting techniques of listed companies in Colombo Stock Exchange (CSE). Although many studies have been conducted in relation to behavioral finance and corporate decisions, sufficient evidences have not yet been found from the previous seminal works relating to the influence of cognitive behavioral biases of managers in the selection and usage practice of the quantitative techniques of capital budgeting process (CBT) or capital investment decision process. Therefore, this study was aimed to investigate three closely related behavioral biases (managerial overconfidence, optimism and risk perception bias) and their influence on the selection and usage practice of capital budgeting techniquesin Sri Lanka. The primary data were collected for this study using a self-administered questionnaire from 104 CFOs working in listed companies in CSE. The study revealed that CFOs optimism and overconfidence were positively correlated with the advanced capital budgeting methods only in NPV andstatistically not significant with IRR and PI. Meanwhile, both cognitive biases werestatistically not significant with PB, ARR and DPBof simple capital budgeting methods. However,CFOs optimism and overconfidence werepositively correlated with RO and SA of sophisticated capital budgeting methods.  Meanwhile,CFOs risk perception was not supported with any of the methods other than PB. The study also summarized that firms in listed in CSE rarely use sophisticated capital budgeting methods for their capital investment decision. This study concludes that manager’s behavioral characteristics significantly influence on the selection and usage practice of capital budgeting techniques of listed companies in Colombo Stock Exchange (CSE).