Can two biases be better than none? complementarity between CEO overconfidence and accounting conservatism

Abstract

We study the joint effect of CEO overconfidence and accounting conservatism on firm performance and value. Successful innovation involves trial and error. An overconfident CEO is more willing to initiate daring investment projects, but also subjects the firm to excessive risk. Accounting conservatism (also referred to as prudence), on the other hand, accelerates the recognition of bad news, giving managers additional time to search for creative solutions that could not be anticipated before the project was undertaken. The theory of innovation, therefore, predicts that CEO overconfidence and accounting conservatism are complementary, i.e., the presence of both biases improves the firm's performance relative to the baseline case, especially if the firm operates in a dynamic, fast-changing environment.