An Empirical Research On Managerial Overconfidence And Accounting Conservatism

With the improvement of capital market, the quality of financial information has been improved. Since the1930s, as an important information quality characteristic, the accounting conservatism has been payed close attention to by the academic and the practice. Accounting conservatism is:the confirmation of bad news should be more timely than the confirmation of good news. Existing accounting standard in China, however, requires the management more professional judgment, and they may choose the accounting policies which can meet the demand of their own interests, which makes disclosure surplus not to accord with real surplus seriously, resulting in reducing the conservatism of financial reports. From the perspective of resource optimization, low conservatism of financial information will lead to a waste of resource, and high conservatism of financial information will improve the efficiency of resource allocation.The conservatism of financial information is influenced by the managerial decisions. In addition to the policy environment, managerial decisions also are affected by the managerial psychological characteristics. Especially in the increasingly complex economic environment, the management could not effectively apply so multifarious information to form an efficient report to support them to make rational decisions. Through summarizing the cases, scholars found that the irrational psychology is the key factor that causes the failure of decision making, and overconfidence is the important performance of managerial irrational features. Academic researches on managerial overconfidence are unceasingly rich. For example, Jiang Fuxiu etc.(2009) researched the irrational features, and pointed out that the managerial overconfidence is positively related to the possibility of financial failure. Malmendier, Tate and Yan (2011) pointed out that the overconfident management may distort the financial policies.The development of behavioral psychology provides a new perspective on accounting research. Due to the control illusion deviation and self-serving attribution, the managers are apt to be overconfident, and easily overestimate the earnings, eventually to effect the financial information. On the basis of the researches of psychology, this article focuses on analyzing how overconfident managers influence accounting conservatism. Considering the internal characteristic, growth has a significant impact on managerial psychology, and then influences financial reports. In addition, from the perspective of external factors, managerial psychological state is bound to be affected by the external environment, therefore this paper will explore the how economic environment factors affect the relationship between the managerial overconfidence and accounting conservatism. From the perspective of psychology, this paper will provide a new perspective to the research of corporate governance.The logic is organized as follows:(1)On the theoretical analysis, by clarifying the existing literature, from the illusion of control, self-serving attribution and traditional concepts to explain managerial overconfidence, the author refines the overconfident management’s performance:the preference for high-risk projects, the high expected earnings in the future. Based on contract theory and principal-agency theory, this paper analyzes the motivations, the possibility and the ways of how overconfident management reduces accounting conservatism.(2) In terms of research design, apply the Khan-Watts (2009) model to estimate the accounting conservatism. And regard management as overconfident management meeting the following conditions:when the enterprise’s annual yield is lower than the average industry yield, the management still maintain or increase the number of their stocks. Select the2007-2012annual data, and design the regression model referring to the Khan and Watts (2009) model.(3) In terms of empirical analysis, this paper analyzes how the managerial overconfidence influences accounting conservatism. Secondly, for the different growth’s company, analyzes how managerial overconfidence influences accounting conservatism. In the final, in the different economic situation, analyzes how managerial overconfidence influences accounting conservatism.Based on the above analysis, the content is organized as follows:The first part is an introduction, including the purpose, research significance, research methods, research framework and research contributions. The literature review section intends to discuss the previous literatures. This chapter respectively literatures managerial overconfidence, accounting conservatism. Clarify the existing researches, including from the measure methods and factors, and their economic consequences.The third part presents the theoretical analysis. Firstly, the behavioral finance theory, such as self-serving attribution theory and Chinese traditional Junchen concept can attribute to the overconfidence. On the basis of the principal-agent theory, this chapter analyzes the influence of principal-agent theory on accounting conservatism. And then analyzes why and how managerial overconfidence affects accounting conservatism in theory.The fourth part presents the research design. This chapter firstly develops the hypotheses, and then select data from2007to2012, excluding the observations which are not applicable to this research. According to Khan and Watts’model, estimate the value of accounting conservatism, measure the dependent variable-managerial overconfidence, select the control variables and design the regression model.The fifth part presents the empirical analysis. This chapter mainly includes the descriptive statistics of variables, the correlation analysis and multiple regression analysis and robustness test.The sixth part reveals the conclusions, enlightenments and prospects. This chapter concludes mainly the conclusions and puts forward the enlightenments, finally summarizes the shortcomings of this paper and the research prospects in the future.In this paper, the main research conclusions are:(1) Under the influence of the control illusion deviation and traditional concepts, the management appears overconfident, and self-serving attribution will strengthen managerial overconfidence. Due to the incompleteness of contract and the conflicts of principal-agent, the overconfident managers have the motivations, the possibility and the ways to reduce the conservatism of accounting information. For example over-estimate the future returns of investment projects, and reflect the good news in the financial information in advance, delay the confirmation of bad news. As a result, managerial overconfidence will reduce accounting conservatism.(2) The higher growth of the company, the greater degree that its managerial overconfidence reduces accounting conservatism. To maintain rapid growth, the high-growth companies’ managers will be more overconfident, and they often prefer risky projects, and tend to confirm earnings in the process of financial report form in advance, so they delay the recognition of the loss and further reduce the accounting conservatism.(3) Compared with bad economic situation, the good economic situation will strengthen the negative relationship between managerial overconfidence and accounting conservatism. Good economic situation makes the managers prefer risky decisions. To make financial reports more attractive, they also may follow other confident managers, which will make managerial overconfidence more prominent, thus the degree of accounting conservatism is much lower.The contributions of this paper are:(1) This paper researches how the managerial overconfidence influences accounting conservatism, enriching the integrated boundary theory of behavioral science and accounting research. Previous literatures indicated that contract, litigation, regulation and taxation can affect the accounting conservatism. However, this research focuses on the managers’behavior, to study how the psychological characteristic (overconfidence) influences accounting conservatism, enriching the factors that affect the accounting conservatism.(2) The unique characteristic of this paper is to apply the Chinese traditional culture " Junchen concept" to explain the cause of managerial overconfidence. In addition, from the points of the theory, further analyzes the motivations, the possibility and the ways that managerial overconfidence affects accounting conservatism, providing a new perspective on the research of managerial overconfidence in theory.(3) This research provides the empirical evidences that the internal factors of growth influences the relationship between managerial overconfidence and accounting conservatism. Secondly, considering from the external factors, analyze how the economic situation influences the relationship between managerial overconfidence and accounting conservatism.The shortcomings of this paper are shown in the following:(1) Measurement methods should be improved. Firstly, managerial overconfidence is difficult to measure. Managerial overconfidence inherently belongs to the scope of psychology, therefore, the author anticipates that the future research will apply investigation to measure the overconfidence appropriately. Secondly, the model of accounting conservatism needs to be improved. Based on the background of China’s capital market, however, the stock prices do not fully digest the good news and bad news in time. Therefore, the econometric model should be modified appropriately, for better reflecting the actual background of our capital market.(2) The influence of managerial overconfidence on accounting conservatism will change as their experience and age changing. So, by adopting experimental approach, the further research can track the continuous impact of overconfidence on accounting conservatism from the perspectives of the short-term and the long-term.(3) This paper only considers that how the managerial overconfidence influences accounting conservatism. Besides this factor, the conservatism of accounting formation is influenced by many factors. Therefore, the author anticipates that, future research may add the psychological characteristics of investors into the model for analyzing the comprehensive influence on the accounting conservatism.