Heuristics, biases, and framing effects impede managers from making the best use of the traditional tools of corporate finance, causing them to make faulty decisions that destroy value. The main biases discussed in the chapter are excessive optimism, overconfidence, confirmation bias, and the illusion of control. Managers are inclined to choose negative net-present-value projects because they are excessively optimistic about the future prospects of their firms, overconfident about the risks they face, discount information that does not support their views, and exaggerate the extent of control they wield over final outcomes.

The main heuristics discussed relate to representativeness, availability, anchoring and adjustment, and affect. Managers are prone to make faulty decisions about uses of funds because they place too much reliance on stereotypic thinking when forming judgments, attach too much emphasis to information that is readily available, become overly fixated on numbers in their analyses, and place too much reliance on intuition.

The main topics discussed in the section on framing effects are loss aversion and aversion to a sure loss. Managers are inclined to make faulty decisions about investment policy and financing because they are unduly sensitive about potential future losses and find it difficult to accept losses that have already occurred.

Managers need to be aware that psychological phenomena also cause investor errors that can result in the mispricing of the securities issued by their firms. Avoiding bias, or debiasing, is a major challenge that generally requires a sophisticated, disciplined approach.