Managerial Overoptimism, Discretionary Disclosure, and Certification

Abstract

We examine the effect of managerial overoptimism on discretionary disclosure of subjective information, such as earnings forecasts, and the decision to acquire external certification. The market applies a discount upon disclosure to capture the possibility that the revealed subjective expectation is too optimistic. The resulting mispricing incentivizes objective managers to acquire certification, allowing them to separate from overoptimistic managers’ disclosures. Depending on the certification market structure, the certification fee, and the extent of overoptimism, the disclosure-certification equilibrium may be: i) Separating, where only objective managers acquire certification, ii) pooling, where both manager types disclose without certification, or iii) partially pooling, where the objective managers acquire certification only for sufficiently favorable information.

Keywords: Discretionary Disclosure, Managerial Overoptimism, Mispricing, Sentiment, Certification, Assurance Engagements

JEL Classification: D91, M41, M42