Managerial Overconfidence and Accounting Conservatism

Authors


  • Accepted by Phil Berger. We gratefully acknowledge comments received from Carol Ann Frost, Christo Karuna, Carol Liu, Mary Lea McAnally, Mike Neel, Kaye Newberry, Ananth Seetharaman, Ken Reichelt, Darren Roulstone, Yan Sun, Sam Tiras, Senyo Tse, Ross Watts, Chris Wolfe, an anonymous reviewer, and workshop participants at the 2012 McMaster Accounting Symposium, Louisiana State University, University of Houston and University of North Texas.

ABSTRACT

Overconfident managers overestimate future returns from their firms’ investments. Thus, we predict that overconfident managers will tend to delay loss recognition and generally use less conservative accounting. Furthermore, we test whether external monitoring helps to mitigate this effect. Using measures of both conditional and unconditional conservatism respectively, we find robust evidence of a negative relation between CEO overconfidence and accounting conservatism. We further find that external monitoring does not appear to mitigate this effect. Our findings add to the growing literature on overconfidence and complement the findings by Schrand and Zechman [2011] that overconfidence affects financial reporting behavior.

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