The main objective of this chapter is for students to demonstrate that they can identify key psychological phenomena that serve to obstruct good corporate governance.

After completing this chapter students will be able to:

1. Explain how overconfidence prevents corporate boards from putting compensation systems in place that align the interests of managers and shareholders.
2. Explain the role of prospect theory casino effects in aligning the interests of shareholders and managers.
3. Describe how aversion to a sure loss can interfere with the alignment of the interests of investors and the interests of auditors engaged to monitor managers.
4. Analyze how, because of aversion to a sure loss and overconfidence, stock option–based compensation can exacerbate agency conflicts.