Executive overconfidence and the slippery slope to financial misreporting. (2012)

“Overconfident executives are more likely to exhibit an optimistic bias and thus are more likely to start down a slippery slope of growing intentional misstatements.

Schrand, C.M., University of Pennsylvania, The Wharton School
Zechman, S.L.C., University of Chicago Booth School of Business

Journal of Accounting and Economics 53(1-2): 311-329.

A detailed analysis of 49 firms subject to US Accounting and Auditing Enforcement Releases (AAERs) suggests that approximately one-quarter of the firms meet the legal standards of intentional fraud.

In the remaining three quarters, the initial misstatement reflects an optimistic bias that is not necessarily intentional. Because of the bias, however, in subsequent periods these firms are more likely to be in a position in which they are compelled to intentionally misstate earnings.

Overconfident executives are more likely to exhibit an optimistic bias and thus are more likely to start down a slippery slope of growing intentional misstatements.

Evidence from a high-tech sample and a larger and more general sample support the overconfidence explanation for this path to misstatements and AAERs.

Access the full paper here: Executive overconfidence and the slippery slope to financial misreporting.