The Effects of the CEO’s Perceptual Bias in Economic Decision-Making and Judgment on the Capabilities of the Financial Reporting Quality

Document Type: Research Paper

Authors

Department of Accounting, Shahrood Branch, Islamic Azad University, Shahrood, Iran

10.22034/amfa.2019.1864633.1201

Abstract

The current research sets out to identify and scrutinize the impact of the CEO’s perceptual biases in judgment and economic decision-making on the reporting quality of the firms listed on the Tehran Stock Exchange. Adopting a mixed method, the present study first seeks to detect the components and indices of CEO’s perceptual biases via critical appraisal and with the special participation of 10 accounting experts. Afterwards, the rec-ognized indices are set to undergo a Delphi analysis given the mean and the coefficient of agreement. The verified indices are then adapted to the ac-counting models and analyzed in the form of research hypotheses. The re-sults of qualitative analysis using Delphi method verify the reliability of 16 indices out of 22 ones. Regarding the quantitative analysis, the association between the indices of the CEO’s perceptual biases in judgment and econom-ic decision-making, and the primary proxies of financial reporting, namely reliability and competitiveness is tested. The findings reveal that the indices of the CEO’s perceptual biases in judgment and economic decision-making exert a significantly negative effect on financial reporting reliability and competitiveness.

Keywords

Main Subjects


[1] Assadi, G., Naderi Nooreyni, M., Sarfaraz, M. The moderating role of financial reporting quality on the relationship between working capital management and financial performance. Accounting Empirical Research of Financial, 2018, 5(2), 131-150. http://jfak.journals.ikiu.ac.ir/article_1442.html (In Persian)

[2] Lee, Y., Strong, D. M., Kahn, B. K. and Wang R. Y. AIMQ: A methodology for information quality assessment. Information & Management, 2002, 40(2), P. 133-146. Doi:10.1.1.6.2407

[3] Aflatooni, A., Nemati, M., The Role of Financial Reporting Quality and Disclosure Quality in Increasing Commercial Credit, Journal of Accounting and Auditing Review, 2018, 25(1), P. 1-20. Doi: 10.22059/acctgrev.20 18.249054.1007787. (In Persian)

[4] Bruno S., and L. Zuo, Relative Optimism and the Home Bias Puzzle, Review of Finance, 2017, 21, P. 2045-2074. Doi: http://doi.org/ 10.1093/rof/rfw021

[5] Carpenter, M.A., The Handbook of Research on Top Management Teams (Edward Elgar Publishing, Inc., Northampton, MA). 2011.

[6] Ben-David, I., Graham, J., Harvey, C., Managerial overconfidence and corporate policies, Working Paper, 2007, http://doi.org/ 10.3386/w13711

[7] Selody, K., Is the risk worth the reward for top female executives?, Working paper, 2010.https://www.aeaweb.org/conference/2011/retrieve.php?

[8] Datta, S., Data, M, I., Raman, K., Executive Compensation and Corporate Acquisition Decisions, The Journal of Finance, 2002, 56 (6), P. 2299-2336. https://doi.org/10.1111/0022-1082.00406

[9] Roll, R., The hubris hypothesis of corporate takeovers, Journal of Business, 1986, 59, P.197-216. https://www.jstor.org/stable/2353017

[10] Heaton, J. B. Managerial optimism and corporate finance, Financial Management, 2002, 31, P.33-45. https://doi.org/ 10.2139/ssrn.71411

[11] Malmendier, U. Tate, G., & Yan, J. Overconfidence and early-life experiences: The effect of managerial traits on corporate financial policies, The Journal of Finance, 2011,66(5), P.1687-1733. https://doi.org/ 10.2307/41305173

[12] Galasso, A., Simcoe, T, S. CEO Overconfidence and Innovation, National Bureau of Economic Research, 2010, 57(9), P. 3-45. https://doi.org/ 10.1287/mnsc.1110.1374

[13] Lundholm, R. J., Myers, L. A. Bringing the future forward; the effect of disclosure on the returns- earning relation, Journal of accounting research, 2002, 40(3): 809-839. https://doi.org/10.1111/1475-679X.00072

[14] Healy, P., Hutton, A. and Palepu, K. Stock performance and intermediation changes surrounding sustained increases in disclosure. Contemporary Accounting Research, 1999, 16(3), P. 485-520. https://doi.org/10.1111 /j.1911-3846.1999.tb00592.x

[15] Hirshleifer, D. Investor Psychology and Asset Pricing, Journal of Finance, 2001, 4, P. 1533-1597. https://doi.o rg/10.1111/0022-1082. 00379

[16] Karimi, K., Rahnamay-Roodposhti, F. Behavioral Biases and The Incentives of Earnings Management. Journal of Management Accounting and Auditing Knowledge, 2015, 4,P. 15-32, http://jmaak.srbiau.ac.ir/article_7711.html. (In Persian)

[17] Suresh, A. Understanding Behavioral Finance Through Biases and Traits of Trader Vis-à-vis Invester, Journal of Finance, Accounting and Management, 2013, 4(2), P. 11-25. https://ssrn.com/abstract=2349672

[18] Shafer, W, E., Wang, Zh. Effects of ethical context and Machiavellianism on attitudes toward earnings management in China, Managerial Auditing Journal, 2011, 26(5), P. 372 – 392. https://doi.org/10.1108/0268690111 1129553

[19] Lovallo, D., Kahneman, D. Delusions of Success: How Optimism Undermines Executives, Decisions, Harvard Business Rewiew, 2003, 81, P. 56-63. https://www.ncbi.nlm.nih.gov/pubmed/12858711

[20] Jones, D., Paulhus, D. Machiavellianism. In M.R. & R.H. Hoyle (Eds), Individual Differences in Social Behavior, 2009, P. 93-108, New York: Guilford

[21] Murphy, P. Attitude, Machiavellianism, and the Rationalization of Misreporting, Accounting, Organizations, and Society, 2012, 37 (4), P. 242-259. https://doi.org/10.1016/j.aos.2012.04.002

[22] Fallah Poor, S., Abdollahi, G. Determining and Prioritizing Behavior Biases of Investors in Tehran Stock Exchange Market: a Fuzzy AHP Approach. Financial Research Journal, 2011, 13(31), P. 99-120.(In Persian)

[23] Saghafi, A., Arabmazar, M. Financial Reporting Quality and Investment Inefficiency. Journal of Financial Accounting Research, 2011, 2(4), P. 1-20. http://far.ui.ac.ir/article_16899.html (In Persian)

[24] Ulupinar, B. The effect of managerial entrenchment on analyst bias, Global Finance Journal, 2018. Doi:10.1016/j.gfj.2018.04.001

[25] Koga, M., Kato, H. Behavioral Biases in Firms’ Growth Expectations, Bank of Japan Working Paper Series, 2017. Nihonbashi-Hongokucho, Chuo-ku, Tokyo 103-0021, Japan.

[26] Chollet, B., Geraudel, M., Khedhaouria, A., Mothe, C. Market knowledge as a function of CEOs' personality: A fuzzy set approach, Journal of Business Research, 2015, http://dx.doi.org/10.1016/j.jbusres.2015.10.137.

[27] Bilgehan, T. Psychological biases and the capital structure decisions: a literature review, Theoretical and Applied Economics, 2014, 12(601), P. 123-142. https://doi.org/10.1016/j.compag.2014.05.022

[28] Mohamed Ali, A., Anis, J. CEO emotional bias and dividend policy: Bayesian network method, Business and Economic Horizons journal, 2012, 7(1), P. 1-18. https://doi.org/ 10.15208/beh.2012.1

[29] Malmendier, U. & Tate, G. CEO overconfidence and corporate investment, European Financial Management, 2005, 11(5), P. 649-659. https://doi.org/10.1111/j.1540-6261.2005.00813.x

[30] Ahmed, A. S., & Duellman, S. Managerial overconfidence and accounting conservatism. Journal of Accounting Research, 2013,51(1), P. 1-30. https://doi.org/10.1111/j.1475-679X.2012.00467.x

[31] Ben-David, I. Graham, J., & Harvey, C. Managerial miscalibration. National Bureau of Economic Research. 2010. Working Paper Series No. 16215. Available in: http://www.nber.org/papers/w16215.

[32] Hasani Alghar, M., Rahimian, N. The Effect of Managerial Overconfidence on Debt Maturity Structure in Listed Companies in Tehran Stock Exchange. Asset Management and Financing, 2018, 6(1), P. 89-106. doi: 10.22108/amf.2017.21350. (In Persian)

[33] Mehrani, S., Taheri, M. Managerial Overconfidence and Earning Forecast Errors. Empirical Research in Accounting, 2018, 7(2), P. 147-164. Doi: 10.22051/jera.2017.7386.1072. (In Persian)

[34] Lewellen, W. G., Badrinath, S. G. On the measurement of Tobin’s q. Journal of Financial Economics, 1997, 44(1), P. 77-122.

[35] Campbell, T. C., Gallmeyer, M., Johnson, S. A., Rutherford, J., & Stanley, B. W. CEO optimism and forced turnover. Journal of Financial Economics, 2011, 101(3), P. 695-712. https://doi.org/10.1016/j.jfineco.2011.03.004

[36] Gelb, D.S., & Zarowin, P. A. Corporate disclosure policy and the information of stock prices. Review of accounting studies, 2002, 7(1), P. 33–52. https://doi.org/10.1023/A%3A1017927530007

[37] Chen, G., M. Firth. the Accuracy of Profit Forecasts and their Roles and Associations with IPO Firm Valuations. Journal of International Finacial Management and Accounting, 1999, 12(3), P. 202-226. https://doi.org /10.1111 /1467-646X.00051

[38] Aderson, T. W., Hsiao. C. Formulation and estimation of dynamic modes using panel data. Journal of Econometrics, 1982, 18(1), P. 47-82. https://doi.org/10.1016/0304-4076(82)90095-1

[39] Richardson, S. Over-investment of free cash flow. Review of Accounting Studies, 2006, 11(2), P. 159-189. https://doi.org/ 10.1007/s11142-006-9012-1

[40] Biddle, G. and Hilary, G. Accounting quality and firm-level capital investment. The Accounting Review,2006, 81(11), P. 963-982. https://doi.org/ 10.2308/accr.2006.81.5.963

[41] Yang, J., and Jiang, Y. Accounting information quality, free cash flow and overinvestment: A Chinese study. The Business Review, 2008. 11 (1), P. 159-16, https://doi.org/10.1016/j.anucene.2008.01.055

[42] Tehrani, R., Hesarzadeh, R. The Effect of Free Cash Flow and Financial Constraint on Over-Investment and Under-Investment, Accounting Research, 2009, 1(3), P.50-67. (In Persian)

[43] Biddle, G., Hilary, G. and Verdi, R. S. How Does Financial Reporting Quality Relate to Investment Effiiency?. Journal of Accounting and Economics, 2009, 48 (4), P. 112-31. https://doi.org/10.1016/j.jacceco.200 9.09.001

[44] Myers, S. C., Majluf, N. S. Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have, Journal of Financial Economics, 1984, 13)2), P. 87-221. https://doi.org/10.1016/0 304-405X(84)90023-0

[45] Houmes, R.  Skantz, T. Discretionary accruals and highly valued equity. Journal of Business Finance & Accounting, 2010, 37(10), P. 60-92. https://doi.org/10.1111/j.1468-5957.2009.02179.x

[46] De Franco, G., S. Kothari, and R. Verdi. The Benefits of Financial Statement Comparability, Journal of Accounting Research, 2011, 49(2), P. 895–931. https://doi.org/10.1111/j.1475-679X.2011.00415.x

[47] Sajadi, S., Takor, R., Mahmoudi, A. Relationship between Institutional Investors and Earnings Quality, Empirical Studies in Financial Accounting, 2011, 8(29), P.115-137. http://qjma.atu.ac.ir/article_4310.html. (In Persian)

[48] Beaver W, H. Financial reporting: an accounting revolution, Englewood Cliffs, N.J.: PrenticeHall. 1989.

[49] Chambers, A, E., Penman, SH. Timeliness of reporting and the stock price reaction To earnings announcements, Accoumting Review, 1984, 22(2), P. 21–47. https://doi.org/ 10.2307/2490700.

[50] Ohlson, J., Feltham, G. Valuation and clean surplus accounting for operating and financial activities,Contemporary Accounting Research, 1995, 11(2), P. 689-731. https://doi.org/10.1111/j.1911-3846.1995.tb00462.x

[51] Francis, J., LaFond, R., Olsson, P. M. Schipper, K. Costs of  Equity and Earnings Attributes, The Accounting Review, 2004,79(4), P. 967-1010. https://www.jstor.org/stable/4093083

[52] Dechow, P. & Dichev, I. The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors. The Accounting Review, 2002,77, P. 35-59. https://www.jstor.org/stable/3203324

[53] Rahmani, A., Gholami Gakieh, F., Pakizeh, K. The Impact of Financial Flexibility on Investment Ability and Firm’s Value Enhancing, 2012, 4(2), P. 53-76. doi: 10.22099/jaa.2012.1660. (In Persian)

[54] Byoun, S. Financial Flexibility and Capital Structure Decision, Working Paper, Universitu of Baylor. 2008. https://doi.org/10.2139/ssrn.1108850

[55] Haghighat, H., Bashiri, V. Relationship between Financial Flexibility and Capital Structure, 3(8), P.49-71. doi: 10.22103/jak.2012.3. (In Persian).

[56] Schoubben, F. & Hulle, C. V. Stock listing and financial flexibility, Journal of Business Research, 2011, 64(11), P. 483-489. https://doi.org/10.1016/j.jbusres.2010.04.002

[57] Marchica, M. T. Mura. R. Financial flexibility, investment ability, and firm value: Evidence from firms with spare debt capacity, Financial Management, 2010, 22(4), P. 1339-1368. https://doi.org/10.1111/j.1755-053X.2010.01115.x

[58] Faulkender, M., & Wang, R. Corporate financial policy and the value of cash. The Journal of Finance, 2006, 61(4), P. 1957–1990. https://doi.org/10.1111/j.1540-6261.2006.00894.x

[59] Sheri Anaghiz, S., Bolu, G., Mohseni Maleki Rastaghi, B. The Relation between Financial Flexibility and Financing Type of Firms Listed in Tehran Stock Exchange (TSE), Empirical Research in Accounting, 2017, 6(2), P. 171-190. doi: 10.22051/jera.2016.2787. (In Persian)

[60] Izadikhah, M., Improving the Banks Shareholder Long Term Values by Using Data Envelopment Analysis Model, Advances in Mathematical Finance and Applications, 2018, 3(2), P. 27-41. doi: 10.22034/AMFA.2018.540829

[61] Parsa, B., Sarraf, F., Financial Statement Comparability and the Expected Crash Risk of Stock Prices. Advances in Mathematical Finance and Applications, 2018, 3(3), P. 77-93. doi: 10.22034/amfa.2018.544951

[62] Hoseini, A., Investigation of Effects of Corporate Reporting Quality, Timeliness and Quantity for Disclosure and Reliability of Financial Reports on Stock Price Delay. Advances in Mathematical Finance and Applications, 2016, 1(1), P.67-83. doi: 10.22034/amfa.2016.526245