The Effect of Company Performance to Managerial Risk Taking: an Insight from Prospect Theory

Abstract

One of the fundamental principle in Finance is that people behave in risk averse manner. Risk is only taken if it will result in higher expected value. The higher the risk, the higher also value to be expected. However, Prospect Theory predicts that in loss situation people will exhibit risk seeking behaviour. We test this hypothesis by evaluating how company performance influence managerial risk taking. It is proposed that low performance will induce managers to be risk seeking, and thus increase the level of managerial risk taking. The result is important as past performance might shift the amount of risk from optimal level, and thus affecting company value negatively. Company management might need to device certain procedures to neutralize the effect of performance to managerial risk taking