J. Basic. Appl. Sci. Res.

, 5(8)62-69, 2015 ISSN 2090-4304

Journal of Basic and Applied
© 2015, TextRoad Publication
Scientific Research
[Link]

Factors Affecting Investment Decision Making: Evidence from Equity Fund

Managers and Individual Investors in Pakistan
Aisha Farooq1, Muhammad Adnan Afzal2, Prof. Dr. Nadeem Sohail3, Muhammad Sajid4
1
Research Scholar, Government College (GC) University Faisalabad, Pakistan
2
Lecturer, College of Commerce, Government College (GC) University, Faisalabad, Pakistan
3
Principal, University Community College, Government College (GC) University, Faisalabad, Pakistan
4
Lecturer, Department of Banking & Finance, Government College (GC) University, Faisalabad, Pakistan
Received: March 29, 2015
Accepted: July 11, 2015

ABSTRACT

Traditional theories of finance assume that investors behave rationally in the stock market, but according to
behavioral finance investors behave irrationally while making their investment decisions. Behavioral finance
explains the effect of investor psychology on their investment decision making.
Purpose - The purpose of the study is to investigate the impact of behavioral factors such as heuristics, risk aversion,
use of financial tools and firm-level corporate governance on investment decision making.
Design/Methodology/Approach– This study use questionnaire technique for primary data collection from equity
fund managers and individuals who invested in commercial banks, insurance companies and stock exchanges of
Pakistan. The study collected 100 responses from individuals and equity fund managers. To accomplish the
objective we use correlation analysis and regression analysis technique.
Findings –The study concludes that Heuristics, Use of financial tools and Firm level corporate governance have
positive and significant Impact on investment decision making, whereas Risk aversion has negative and significant
impact on investment decision making. Moreover, all behavioral factors, firm level corporate and investment
decision making have positive and significant relationship with each other. Stock exchanges and regulatory
authorities may use these results to educate investors about behavioral factors. Findings of this research study may
help to increase the investor’s confidence.
KEYWORDS: Behavioral Factors, Investment Decision Making, Equity Fund Managers, Individual Investors.
JEL Classification: D03, G3

INTRODUCTION

Investment decision making is a challenging activity for investors, especially in the dynamic environment with
multidimensional alternatives. Investment decisions cannot be made in a vacuum by depending on the personal
resources and complex models. Investors must have to be vigilant and up to date to achieve the desired goals.
Behavioral finance is the emerging field which can be helpful for investors to select better investment tools and to
avoid repeating errors in future. Behavioral finance explains the effect of investor psychology on decision making of
their investment.
Behavioral finance concentrates on irrational behavior of investor that has influence on investment decisions
and prices of market.[17]Illustrates how investor behaves and how his behavior influences the financial markets.
According to traditional financial market theories, market participants are rational. However, numerous studies
reveal that investor behavior is not always rational, in fact sometimes it is systematically irrational. Now stock
markets are turn into more unpredictable. The stock markets instability enhances the risk related to investment.
Efficient market hypothesis explain that share prices completely indicate all existing information. EMH is
based on investor information and rationality.[16] define efficient market theory based on the concept that
investors behave rationally they increase expected utility and quickly process all accessible information.
Investor’s perception fluctuates about return and risk of their investment even in the existence of efficient market
hypothesis. Studies done by [6, 18] demonstrate investors utilize repeated patterns of irrational behavior and deviate
from rationality. This deviation raise the risk related with investment and cause volatility in stock markets. In
finance these changes are names as anomalies in financial market.
[7]Make important contribution with their prospect theory in decision making under uncertainty. In prospect
theory they attempt to explore investor’s psychological behavior. Prospect theory explains that when investors are

*Corresponding Author: Muhammad Sajid, Lecturer, Department of Banking & Finance, Government College (GC)
University, Faisalabad, Pakistan (Tel.# 00923146160441~Email ID: muhammadsajid@[Link])

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risk averse they face gains and when they take more risk, they face losses. Now many investors invest in stock
markets so the investors’ behavior, attitude and psychology have impact on stock prices. Investors mostly do fault in
their investment because of their psychological and behavioral biases. The understanding of corporate attributes is
also important because investor’s decision making is influenced by corporate governance at firm level. Firms with
poor governance fail to attract investors.
Different studies investigate that risk aversion and different behavioral factors have impact on investment
decision making but they did not explore that firm level corporate governance have effect on decision making.
Investors’ deviates from rationality their buying and selling behavior generates fluctuation in stock markets so the
financial markets are becoming volatile and share prices fluctuate every day. By using traditional financial tools
stock price movements cannot be judged. The main problem is that investors do not follow the traditional trends of
decision making for their investment decisions and deviate from EMH. Investors do not think about the impact of
behavioral factors on their investment decisions. So there is need to consider all these situations while making
decisions and mitigate the systematic errors in investment decision making.
The core objective of this article is to investigate the effect of behavioral factors such as heuristics, risk
aversion, use of financial tools and firm level corporate governance on investment decision making. Moreover the
specific objectives of this article are:

To check the relationship among behavioral factors and investment decision making.

To check the relationship of firm level corporate governance with investment decision making.

To check the impact of behavioral factors on investment decision making.

To check the impact of firm level corporate governance on investment decision making.
This article will facilitate in recognizing the use of financial tools for investment decision making and will also
help to explain and understand that how emotional and behavioral factors influence the investors decision making.
The current study will help investors and financial practitioners to diminish and overcome the errors in their
investment decision making based on behavioral factors, which could aid to better market stability. Regulatory
bodies (SECP) can also use the results for making policies for stock market.
This research focuses on the following questions:

Dose firm level corporate governance affects investment decision making?

Dose behavioral factors influence investment decision making?

Dose investors risk averse behavior affects the decision making of their investment?

LITERATURE REVIEW

Behavioral Factors Influencing Investment Decision Making

Investment decision making is very difficult task. According to [1] investors must keep themselves update in
multidimensional fields to achieve their desired objective in business. According to most financial and economic
theories individual act rationally and think about all accessible information for decision making of investment. But
behavioral finance believes that investor act irrationally in stock market. [15]Said investor’s psychology, behavioral
biases and emotions lead to systematic error in the way in which they process their information. Studies done by [2,
7] also show that decisions of investors affected by behavioral, emotional and psychological factors.
The empirical findings of studies done by [5]shows that investors make poor trading and investing decisions
because of behavioral biases. [14]Identified many different behavioral factors which have effect on investment
decision making. However study done by [8] illustrate that behavioral factors have positive impact on investment
decision making. According to [2] heuristics have more influence on investor decisions rather than prospect theory.

Heuristics Decision Process

Investors apply mental shortcuts for decision making rather than objectively reviewing the easily accessible
information. Different methods that people use to reduce the effort related to their task called heuristics.
[7]Exemplify that application of heuristics may cause poor decisions. Implementation of heuristics decisions cause
due to shortage of time. The components of heuristics are (Gambler’s fallacy, availability bias, anchoring
representativeness and overconfidence).

Gambler’s fallacy Bias

In gambler’s fallacy, investors expect patterns to be more predictable then they are in reality, then based on
those expected patterns they make investment decision. Gamblers’ fallacy takes place when people improperly
forecast that a trend would reverse subsequently leading to poor market returns. [13]Explain in their study that status
quo investors adopt the previously selected pattern, even if it not the most favorable option.

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Availability Bias
In Availability, bias decision makers rely on easily available information rather than inspecting other
alternatives and procedures. Availability bias referred to as when investors give excessive importance to effortlessly
obtainable information.

Anchoring Bias
Anchoring is a common human propensity to rely too heavily on one attribute or piece of information when
making decisions. Anchoring refers to people's propensity to make estimates about the chances of uncertain events.
Anchoring occur when a value scale is set by current observations.

Representativeness Bias
Representativeness is also a type of heuristics which can be defined as when investors seek to purchase newly
issued stocks and avoid to those stocks which performed badly in past. This behavior show or explain the
overreaction of investor.

Overconfidence Bias
Mostly Investors perceive that they are better than other investors and this propensity to suppose can cause
overconfidence bias that can eventually direct to excessive trading. Studies done by [16] explains in overconfidence
investor overestimate their predictive skills, analysts become overconfident when they have some knowledge in
particular areas. [18]Elucidate that excessive trading leads to overconfidence. Heuristics use in investment decision
making save time, cost and effort but it might cause errors and desirable results might not be achieved.

Risk Aversion
Risk aversion is individual desire to avoid uncertainty. Risk aversion has an effect on investment decisions
under uncertainty. According to [3] risk aversion has negative impact on trading activity of investors and on their
portfolio size. [10] argues that risk aversion directly influence investor wealth by generally making bad decision
According to early study individuals are rational, risk averse, and try to maximize the wealth under difficult
alternatives. [7]Suggest that investors are irrational and they are not consistent in risky choices. Investors perceive
risk after determining it, their risk seeking and risk aversion changes in diverse situations. On the basis of the above
literature, in financial decision making investors do not emerge to be steady towards risk aversion.

Corporate Governance
A system in which companies or organizations are directed and controlled is called corporate governance.
Weak governance leads to ruinous consequences which consequently increase the expenditure of the company.
Corporations who have poor governance are unable to attract investors. [4] Describe that the better developed
systems will help to achieve the objectives of the corporation. Past studies tell us about the inclination of investors
about corporate governance at firm level, which perhaps have effect on their decision making about investment. The
present study follows [4] aspect of assessing firm level corporate governance which includes Transparency,
Fairness, Discipline, Independence Responsibility, Accountability and Social Awareness. Corporate governance
system plays a role towards the value of the organization.

Use of Financial Tools

Financial professional apply various methods and tools to attain better outcome in their investment decisions.
Commonly used tools are capital asset pricing model, technical and fundamental analysis. Practitioners use these
tools to measure return and risk in stock market. Fundamental analysis evaluates the economic environment,
company performance and industry performance before making an investment decision. According to [12]
Investment professionals use a verity of practices for market anticipation across different time horizon.
Research work done by [9] demonstrates that it is vital for the investor to do both fundamental and technical
analysis for deciding the suitable stock. [6]Explore that all users mostly rely on technical and fundamental analysis
and less rely on portfolio analysis. Considering the whole literature, it is obvious that professional investors make
wide use of techniques and methods that diverge from those projected by academics. However technical and
fundamental analysis might still lead in various financial markets, the present study attempts to investigate this
issue.

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THEORETICAL FRAMEWORK

Figure 1: Schematic diagram for the theoretical framework of the selected variables

The above figure 1 shows the projected research model with dependent and independent variables of the study.
The model is originally developed by [8]. The dependent variable is investment decision making, whereas the
independent variables are heuristics, risk aversion, use of financial tools, and firm level corporate governance.
Decision making is affected by all these factors. According to different studies these behavioral factors have positive
and significant relation with investment decision making. The following hypotheses are developed from the above
literature:

RESEARCH HYPOTHESES
H1: There is positive and significant effect of heuristics on decision making of investment.
H2: Risk aversion has negative and significant impact on investment decision making.
H3: Use of financial tool positively and significantly affects the investment decision making.
H4: Firm level corporate governance positively and significantly affect investment decision making.

RESEARCH METHODOLOGY

The population of the study comprised on individual investors and equity fund managers of financial
institutions that invested in stock exchange; it covers mangers of investment banks, insurance companies, equity
investment companies, commercial banks and mutual fund. In this research we used stratified random sampling
technique. The questionnaire technique was used for the collection of primary data from equity fund managers or
Individual investors from different cities like Islamabad, Faisalabad, Karachi and Toba Tek Singh. The sample used
for analysis was one hundred and twenty (120). However, in overall total 100 filled questionnaires were collected
from the above mentioned sectors. The survey was directed in 3 sectors i.e. insurance companies, commercial banks
and equity investment companies owing to homogenous attributes of respondents. The variables items were
measured by a 5point like scale, where 5 denote ‘Always’, 4 represent ‘Very Often’, 3 refer to ‘Sometimes’, 2
signify ‘Rarely’ and1indicates ‘Never’. The Frequencies test for respondents groups is shown below.

Table 1: Frequencies Test

Organizations Frequency Percent Valid Cumulative
Percent Percent
Banks 24 24.0 24.0 24.0
Insurance Company 39 39.0 39.0 63.0
Equity Investment Company 30 30.0 30.0 93.0
Individual 7 7.0 7.0 100.0
Total 100 100.0 100.0

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Total 100 observations collected from the four major groups. 24% of the respondents belonged to banking section,
39% respondents belonged to insurance companies, 30% respondent belonged to equity investment companies and
7% respondent belonged to individuals.

Reliability Test
In this research the data were analyzed by using the SPSS software. Table 4 shows the Cronbach’s Alpha
which represent the reliability (alpha) of gathered data of variables. By applying the Cronbach’s Alpha the internal
consistency was tested of multi-item scales.

Table 2: Cronbach’s Alpha (N=100)

Variables Cronbach’s Alpha Value

Heuristics 0.865
Risk Aversion 0.432
Use of Financial Tools 0.918
Corporate Governance 0.922
Investment Decision 0.941

The Cronbach’s Alpha for heuristic is 0.865 which is larger than 0.5 the minimum accepted value. The
Cronbach’s Alpha for Risk Aversion is 0.432 which is little bit lower than 0.5 the minimum accepted value its due
to the difference in attitude towards risk sensitivity of investors. The Cronbach’s Alpha for Use of Financial Tools is
0.918 which is greater than 0.5 the standard value. The Cronbach’s Alpha for Corporate Governance is 0.922 which
is superior than 0.5 accepted value. The Cronbach’s Alpha for Investment Decision is 0.941 which is greater than
0.5 the standard value.
RESULTS AND DISCUSSIONS

The current study analyzes the behavioral factors impact on decision making of investment. It is an effort to
encapsulate the decision making of those investors who invested in stock exchanges of Pakistan. Moreover, the
sectorial analysis is done to examine the Firm level corporate governance and use of financial tools impact on
investment decision making. The descriptive statistics, ANOVA, regression and correlation analysis are appended
below.

Descriptive Statistics
Descriptive statistics provide quantitative synopsis of all independent or dependent variables. Table 5.1 shows
the values of measures of variability (minimum, maximum, and standard deviation), measure of central tendency
(mean), skewness and kurtosis show the data normality.

Table 3: Descriptive Statistics

N Range Minimum Maximum Mean Std. Variance Skewness Kurtosis

Deviation
Heuristics 100 3.43 1.57 5.00 3.7114 .79058 .625 -.436 -.199
Risk 100 12.75 1.75 14.50 3.6775 1.41702 2.008 4.449 33.832
Aversion
Use of 100 4.00 1.00 5.00 3.7875 .91175 .831 -.663 -.121
Financial
tools
Corporate 99 2.80 2.00 4.80 3.6855 .79551 .633 -.664 -.479
Governance
Investment 100 3.71 1.29 5.00 3.7743 .85430 .730 -.474 -.377
Decision
Making

Correlation Analysis
Correlation analysis is a technique used to find the relationship between two variables. Table no 5
(Correlation Test) shows the correlation matrix of heuristics, risk aversion, firm level corporate governance and use
of financial tools, with investment decision making in equity investment corporations strata where the sample size
was one hundred (100). This correlation matrix describes the relationship among all the variables. This correlation
matrix signifies that all variables are significant at sig value 0.01.

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Table 5: Correlation Test

Variables Heuristics Risk aversion Firm level Investment Use of
corporate decision financial tools
governance making
Heuristics 1
Risk aversion .481** 1
Firm level corporate .720** .510** 1
governance
Investment decision .748** .334** .716** 1
making
Use of financial tools .785** .504** .818** .770** 1

Correlation is significant at the 0.01 level (2-tailed).

The results in the table show the level of co-relational significance between dependent and four independent
variables by bridging coefficient values of Pearson. Heuristics correlation value is 0.748 which show positive and
significant relationship with investment decision making at 0.01 significant levels. Risk aversion is also significantly
correlated with investment decision making by having value 0.334. The correlation value of firm level corporate
governance is 0.716 which depicts the significant relationship with investment decision making. The figure of
coefficient of correlation of use of financial tools is 0.770 which show significant and positive relationship with
investment decision making. The results have shown that investment decision making is highly dependent on all the
four independent variables. While the relationship among the independent and dependent variables are significantly
and positively correlated with each other as shown in table.

Regression Analysis
The regression coefficient is the slope of the line of the regression equation. Table 6 shows the regression
coefficient results of investment decision making.

Table 6: Regression Analysis

1
(β) Std. t Sig. R Square F Durbin-
Error Statistics Watson
(Constant) .261 1.673 .098 .669 47.490 2.010
Heuristics .358 .107 3.633 .000
Risk Aversion -.143 .042 -2.033 .045
Use of Financial .377 .111 3.173 .002
Tools
Corporate .223 .116 2.073 .041
Governance

According to the results shown in table 5.5, it concludes that the model is significant because all the P values of
variables are < 0.05. Here the R square value is 0.669 which means that all independent variables bring 66.9%
variation in dependent variable and is 66.9 % best fitted. F value which is associated with P value is (47.490)
indicate that independent variable moderately explain variation in the dependent variable. The 2Durbin Watson value
is 2.010<3 which describe that the regression model has not the problem of auto correlation because the error terms
are independent.
The regression coefficient (β) of heuristics is .358; p value is 0.000 and t value 3.633 represent that heuristic
has positive and significant impact on investment decision making. The previous studies of [1-2, 8] examine the
relationship and impact of heuristics on investment decision making. According to the findings of these studies
heuristic positively affects the decision making and our results are in line with these studies.
The regression coefficient of risk aversion is -.143, p value 0.045 and t value -2.033 exhibits that risk aversion
has negative impact on investment decision making and this significantly affects the model. It means that when risk
aversion increase then investment decision making becomes more critical or crucial for investors and their decision
making ability will be affected. [3]Said risk aversion has negative impact on investors trading activity and on the
size of their portfolio. According to [10] risk aversion directly affects wealth of investor by producing bad decision
making.

1
F value should be > 0.05
2
Durbin Watson value should be <3

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 J. Basic. Appl. Sci. Res., 5(8)62-69, 2015

The (β) value of use of financial tools is .377, p value 0.002 and t value 3.173 depict that use of financial tools
positively and significantly affect the investment decision making, which proves the application of financial tools in
investment decision making. Our results are matched with the studies done by [2, 6, 8, 12] they demonstrate that all
investors use financial tools or fundamental analysis in their decision making.
Furthermore, corporate governance (β) value is .223, p value 0.041, t value 2.073 illustrates that firm level
corporate governance has positive and significant impact on investment decision making. Our results are in line with
studies conducted by [8, 11] they exhibit that corporate governance of firm has positive or significant impact on
decision making of investment. All independent variables demonstrate significant impact on the dependent variable
but with diverse variation. The results validate all hypotheses H1, H2, H3 & H4.

CONCLUSION AND POLICY IMPLICATIONS

Conclusion
This research study concludes that decision making process of investor is affected by many behavioral factors.
These behavioral factors impact on decision making is vary to different degrees. The current study also checks the
relationship of investment decision making with behavioral factors (heuristics, risk aversion, use of financial tools)
and firm level corporate governance. The response from the sample present that all the behavioral factors and firm-
level corporate governance make influence and contributing towards the decision making process of investors.
The study divulge that risk aversion have significant role in decision making, every investor expose to risk
according to the strategy of their corporation and mostly fund managers have anxious behavior regarding to risk.
Heuristics also play vital role or have influence on decision making; it is a very important factor. Firm-level
corporate governance and use of financial tools are very important determinant of decision making of investors. In
this research we also observe the deviation from the efficient market hypothesis owing to behavioral factors. Most of
the findings of our study are consistent with studies done in the past by other researchers.
The study makes some suggestions for equity fund managers or individual investors to make improvement in their
investing activity by educating themselves about behavioral factors that make influence on their decision making
and cause to their irrational behavior. This could help investors in diminishing the uncertainty in their decision
making of investment and may help them in uplifting their confidence. This may cause to raise their profits and
market efficiency.

Practical Implications& Future Directions

This research will be beneficial for financial professionals, regulatory authorities or investment advisors so
they can understand or focus on those behavioral factors that cause volatility in stock market. This study will help
them to understand the relationship and impact of Corporate Governance on decision making and investor’s
perception toward risk.
The present research is based on investment decision making, firm level corporate governance and three
behavioral factors; we can conduct future research on other behavioral factors like issues of knowledge, over and
under reaction, mental accounting, herd behavior and demographics to better understand the behavior of investor.
The respondents of the present research study are individual investors, banks, insurance companies and equity
investment companies, in further research the study may include other respondents like non-profit organizations,
group of investors and investment firms.

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