Does Accounting Conservatism Mitigate the Shortcomings of CEO Overconfidence?

Posted: 15 Feb 2017

See all articles by Charles Hsu

Charles Hsu

Hong Kong University of Science & Technology

Kirill E. Novoselov

Shanghai University of Finance and Economics

Rencheng Wang

Singapore Management University - School of Accountancy

Date Written: January 27, 2017

Abstract

Overconfident CEOs are more willing to initiate investment projects that require experimentation, yet tend to defer responding to the bad news when the project is not performing as planned. Accounting conservatism accelerates the recognition of the bad news and its dissemination to gatekeepers, making it more likely that the CEO will acknowledge the problem earlier and start searching for solutions. Therefore, firms where both characteristics — CEO overconfidence and accounting conservatism — are present should perform better. Our empirical tests confirm this prediction: firms that practice conservative accounting and are run by overconfident CEOs exhibit better cash flow performance. Our results continue to hold in a variety of settings, including market reactions to acquisitions, cash flow downside risk, and analyst following. Further, the joint positive effect of CEO overconfidence and accounting conservatism on firm performance is stronger in high-uncertainty environments and in firms facing less stringent financing constraints, consistent with theoretical predictions.

Keywords: accounting conservatism, overconfidence, performance, real options, exploration

JEL Classification: D80, G34, M41

Suggested Citation

Hsu, Charles and Novoselov, Kirill E. and Wang, Rencheng, Does Accounting Conservatism Mitigate the Shortcomings of CEO Overconfidence? (January 27, 2017). Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2917039

Charles Hsu (Contact Author)

Hong Kong University of Science & Technology ( email )

Hong Kong
Hong Kong
852-2358-7568 (Phone)
852-2358-1693 (Fax)

Kirill E. Novoselov

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Rencheng Wang

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

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