CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes

26 Pages Posted: 24 Dec 2014

See all articles by Tien‐Shih Hsieh

Tien‐Shih Hsieh

University of Massachusetts Dartmouth - Department of Accounting & Finance

Jean C. Bedard

Bentley University - Department of Accountancy

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems

Date Written: November/December 2014

Abstract

This study examines the relationship of CEO overconfidence with accrual‐based earnings management, real activities‐based earnings management, and targeting to meet or just beat analyst forecasts. Following, we measure “overconfidence” based on the CEO's tendency to hold in‐the‐money stock options, as rational expected utility maximizers should exercise early to avoid overexposure to company idiosyncratic risks. The results show that before the Sarbanes Oxley Act of 2002 (SOX), companies of overconfident CEOs were more likely than other CEOs to engage in managing earnings through accelerating the timing of cash flow from operations and achieving analyst forecast benchmarks. After SOX, we find that overconfident CEOs are more likely to have income‐increasing discretionary accruals. They remain more likely to engage in real activities management through abnormally high cash flows, and also have abnormally low discretionary expenses. These results are consistent with overconfident CEOs feeling less constrained by SOX, and suggest that this individual characteristic works against regulators’ attempts to constrain earnings management by corporate executives. In contrast, we find that the tendency of overconfident CEOs to manage to targets decreases after SOX, perhaps due to changes in investor behavior in the new regulatory environment.

Keywords: CEO overconfidence, executive compensation, earnings management, Sarbanes‐Oxley Act

Suggested Citation

Hsieh, Tien-Shih and Bedard, Jean C. and Zehms, Karla M., CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes (November/December 2014). Journal of Business Finance & Accounting, Vol. 41, Issue 9-10, pp. 1243-1268, 2014. Available at SSRN: https://ssrn.com/abstract=2542428 or http://dx.doi.org/10.1111/jbfa.12089

Tien-Shih Hsieh (Contact Author)

University of Massachusetts Dartmouth - Department of Accounting & Finance ( email )

285 Old Westport Road
N Dartmouth, MA 02747-2300
United States

Jean C. Bedard

Bentley University - Department of Accountancy ( email )

175 Forest Street
Waltham, MA 02452
United States
781-891-2410 (Phone)
781-891-2896 (Fax)

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-234-1052 (Phone)
608-265-5031 (Fax)

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