Executive Overconfidence and the Slippery Slope to Financial Misreporting

Abstract

A detailed analysis of firms subject to SEC Accounting and Auditing Enforcement Releases (AAERs) in the 1990s and 2000s suggests that approximately one-quarter are the result of an act that is consistent with legal standards of intent. In the remaining three quarters, the initial misstatement – generally an overstatement – reflects an optimistic bias that is not necessarily intentional. Because of the bias, in subsequent periods these firms are more likely to be in a position in which they are compelled to manage earnings in growing amounts. Overconfidence is a trait that is associated with optimistic bias. We find results consistent with overconfident executives, who are more likely to exhibit an optimistic bias, being more likely to initially overstate earnings which starts them on the path to growing intentional misstatements.