The Investigating the Economic Consequences of Managers’ Overconfidence in Exchange Companies

The aim of this research is to investigate the economic consequences of managers’ overconfidence in companies listed in Tehran Stock Exchange during 2006-2016. For doing the study, 77 companies were selected as statistical sample. The pooled/paned regression models were applied to analyze of research data in econometric software EViews 9. In the study, dummy variable of Capital Expenditure (CAPEX) was used to measure of the managers’ overconfidence. Also, to calculate of the economic consequences of managers’ overconfidence such as reducing the quality of financial reporting, from the earnings management criterion, increasing the audit expenses, from the natural logarithmic criterion of audit fees, devaluation of the company’s market value, from the index of market value to book value, and increasing financial distress, from the Kurdestani and Tatli indigenous model were exerted. Financial leverage, company size, return on assets, and cash flow from operating were applied as other effective factors on the economic consequences of managers’ overconfidence, too.
Findings indicate that the capital expenditures as index of the managers’ overconfidence have a positive and significant effect on the earnings management, as well as on the increase of audit expenses resulting from the decrease in the quality of financial reporting, and have a negative and significant effect on the decrease in the ratio of market value to book value following the reduction of the quality of financial reporting, too. However, the financial distress of companies is independent from the managers’ overconfidence and the reduction in the quality of financial reporting following it.
Introduction
The correct flow of information in the capital market, as the motor of the economy leads to the right decision making by market practitioners, and ultimately brings economic development and social welfare improvements. Financial reporting is one of the main means of communication between companies with different stakeholder groups. Corporate management plays an important role in financial reporting. In other words, management attributes have a great influence on their decision-making process regarding financial reporting and, consequently, the quality of these reports. Management overconfidence is one of these features.
The results of previous studies indicate that optimistic managers more than logical managers seek to smooth and manage their earnings (Bouwman, 2014, Bolo and Hasani Alghar, 2015, and Khajavi et al., 2016). Schrand & Zechman (2012) believe that managers’ overconfidence has a positive relationship with the likelihood of fraud in financial statements and stronger internal and external governance mechanisms do not reduce this impact.
Hasas Yegane et al. (2015) argue that if an auditor overestimates the personality trait of managers’ overconfidence more than what is expected, and overestimates the risk of financial reporting due to managers' excessive confidence, he/she can demand more and more fees, and complete his/her actions in order to reduce the risk of non-detection. On the other hand, since overconfident managers are more confident in the company's financial reporting process, they try to reduce the scope of audit and pay fewer fees through negotiation. Hence, the relationship between managers’ overconfidence and audit fees is vague.
Overconfidence can lead to decisions that eliminate the value of the company (Roll, 1986). On the other hand, managers’ overconfidence can lead to benefits in the companies. For example, risk-taking incentives by overconfident managers than other managers are less costly (Campbell et al., 2011).
Due to the lack of similar domestic research in order to investigate economic consequences of managers’ overconfidence simultaneously, this question arises as to what are the economic consequences of managers’ overconfidence in the companies listed in Tehran Stock Exchange? Would managers’ overconfidence reduce the quality of financial reporting, increase audit expenses, decrease the company's market value and ultimately increase financial distress among companies in parallel and simultaneously? The main purpose of this research is to answer the above questions.
 
 
2- Hypotheses
Inthis study our hypotheses are:
H1: Managers’ overconfidence leads to a reduction in the quality of corporate financial reporting through increased earnings management.
H2: Increasing earnings management in companies with overconfident managers will increase the expenses of future audits of such companies.
H3: Increasing earnings management in companies with overconfident managers will decrease the value of future of such companies.
H4: Increasing earnings management in companies with overconfident managers will increase the financial distress of such companies.
3- Methods
The empirical methods used include multiple regression models such as pooled/paned regression models.
 
4- Results
Findings indicate that the capital expenditures as index of the managers’ overconfidence have a positive and significant effect on the earnings management, as well as on the increase of audit expenses resulting from the decrease in the quality of financial reporting. They have a negative and significant effect on the decrease in the ratio of market value to book value following the reduction of the quality of financial reporting, too. However, the financial distress of companies is independent from the managers’ overconfidence and the reduction in the quality of financial reporting following it.
 
5- Discussion and Conclusion
In this research, the economic consequences of managers’ overconfidence in companies listed in Tehran Stock Exchange during 2006-2016 was investigated. In general, the results indicate that managers’ overconfidence has a positive and significant effect on the earnings management, as well as on the increase of audit expenses resulting from the decrease in the quality of financial reporting, having a negative and significant effect on the decrease in the ratio of market value to book value following the reduction of the quality of financial reporting, too. However, the financial distress of companies is independent from the managers’ overconfidence and the reduction in the quality of financial reporting following it.
The results about reducing the quality of financial reporting by increasing the amount of earnings management by overconfident managers indicate that optimistic and narcissistic managers more than logical managers are attempting to smooth and manage their earnings, and in such companies, the quality of financial reporting is low.
The results of market devaluation due to the reduction in the quality of financial reporting due to increased earnings management in relation to managers with excessive confident suggest that the managers’ overconfidence would increase the likelihood of falling stock prices.