Executive overconfidence and the slippery slope to financial misreporting

A detailed analysis of 49 firms subject to AAERs suggests that approximately one-quarter of the misstatements meet the legal standards of intent. 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. ⺠About 1/4 of our 49 AAER firms meet the legal standards of intentional fraud. ⺠In the remaining 3/4 the initial misstatement reflects an optimistic bias. ⺠This bias makes the manager more likely to misstate in increasing amounts later. ⺠Overconfident executives are more likely to exhibit optimism. ⺠Thus, overconfident executives are more likely to start down the slippery slope.