Conglomerate Investment, Skewness, and the CEO Long-Shot Bias

Making investment decisions that maximize shareholder value is the central task of corporate managers, and every MBA curriculum features state-of-the-art valuation tools prominently. Nevertheless, making investment decisions in the real world is difficult because even the best valuation tools rely to a considerable extent on assumptions that are subjective. Consistent with substantial residual uncertainty around true project value, about half of the CEOs mention in surveys “gut feel” as an important or very important factor in their investment and capital allocation decisions. As there is by now overwhelming evidence suggesting that intuitive reasoning in financial matters frequently leads to biased and therefore suboptimal decisions, a natural—and potentially very important—question is whether biases distort optimal capital allocation in firms.