Predicting Accounting Misconduct: The Role of Firm-Level Investor Optimism
Motivated by a large literature on how firm-specific resources (such as leadership and management skills, strategies, organizational capabilities and intellectual properties) drive firm performance, we propose and find that heterogeneity in investor optimism regarding firm-specific attributes plays a very important role in influencing the managerial propensity to manipulate financial statements. When firm-level investor optimism is moderate, the incidence of accounting misconduct increases, but it decreases when investors are highly optimistic. Further, market reaction to the announcement of financial restatements is more negative when investors held more optimistic firm-specific beliefs at the time of initial misstatement. These findings are robust to alternative firm-specific optimism measures linked to analysts, general investors and unsophisticated individual investors, controls for market-wide consumer sentiment unexplained by macroeconomic factors, economy-wide and industry-level optimism, potential selection bias and reverse causality. Our analysis highlights the importance of firm-level investor optimism in predicting, preventing and detecting accounting misconduct.
KeywordsInvestor optimism Financial reporting Accounting misconduct Irregularity Earnings management Market reactions
JEL ClassificationG10 G14 G34 G38
We are very grateful to Steven Dellaportas (the editor) and two anonymous referees for their very helpful comments. We thank Jonathan M. Karpoff, Allison Koester, D. Scott Lee and Gerald S. Martin who generously shared with us the Federal Securities Regulation (FSR) database. We thank Andrew J. Leone for generously sharing the General Accountability Office (GAO) data on classification of errors and irregularities. We appreciate insightful comments from Assaf Eisdorfer, Efdal Misirli, John Clapp, Joseph Golec, John Glascock and seminar participants at University of Connecticut, the 2016 Annual Meeting of Southern Finance Association (SFA) and the 4th India Finance Conference.
Compliance with Ethical Standards
Conflict of interest
The authors declare that they have no conflict of interest.
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