Subject: Rights Issue as the only source of funding during the “credit crunch” Or Why only the current investors don’t lose faith in their targets’

Since the credit crisis started more than 2 years ago many companies got into financial problems. They have encountered a tough funding environment in which banks where completely reluctant to lend and public offerings where (and still are) completely out of the question. It has become common for companies to approach their current investors to reach out for their pockets and inject money directly to the company (“Right Issues”). Some companies where in severe liquidity problems that many analysts were questioning whether it makes sense to invest more cash.
Well, the questions that should be asked are: why current investors see a higher potential in companies of their portfolio than they shoudl? If those were really economically viable investments, should we expect players other than those current investors (e.g PEs, banks and other financial institutions) to be also interested in injecting cash especially under favorable low valuations (under the assumption that the market is not that inefficient)? Are current investors become more ‘emotionally attached’ to their companies and thus an easier target of management to get more funds?

The answers lie primarily in the human tendency to fall into the trap of “sunk cost fallacy”. Meaning, once I already invested $10m in a company, it seems not worth it to let go now. I dream that things could improve and profits will eventually come, although I should analyze my new investment decision on a standalone basis and ignore my initial investment.
In addition, people have a very hard to time to aggregates gains and losses as they have a separate “mental account” for each and every action. From the exact same reason we hate selling a stock that is losing although the financial results indicate that it might not make sense to hold it anymore.
Throw a bit of overconfidence from investors, political social pressure on shareholders not to let companies go under water in times of trouble, and professional reputation to maintain as consistent logical investors, and you have a tasty recipe for series of bad investments.
What can we do about it? The first step is to recognize that the problems exist and to be aware that humans are rarely rational in their behavior.