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The effect of managerial overconfidence on the conditional conservatism and

real earnings management

Article  in  Journal of Islamic Accounting and Business Research · January 2020

DOI: 10.1108/JIABR-03-2017-0030

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JIABR
11,3 The effect of managerial
overconfidence on the conditional
conservatism and real earnings
708 management
Received 2 March 2017 Mahdi Salehi and Mahmoud Lari DashtBayaz
Revised 21 May 2017
31 December 2017
Department of Economics and Administrative Sciences,
21 June 2018 Ferdowsi University of Mashhad, Mashhad, Iran
Accepted 11 July 2018
Somayeh Hassanpour
Department of Economics and Administrative Sciences, Qaenat Branch,
Islamic Azad University, Qaenat, Iran, and
Hossein Tarighi
Department of Economics and Administrative Sciences,
Attar Institute of Higher Education, Mashhad, Iran

Journal of Islamic Accounting and
Business Research
Vol. 11 No. 3, 2020
pp. 708-720
© Emerald Publishing Limited
1759-0817
DOI 10.1108/JIABR-03-2017-0030
Abstract
Purpose – This study aims to investigate the effects of managerial overconfidence on conditional
conservatism and real earnings management among companies listed on the Tehran Stock Exchange (TSE).
Design/methodology/approach – In this paper, the authors used the model of Ball and Shivakumar
(2006) for measuring the effect of moderating overconfident management on conditional conservatism in
accounting; moreover, the model of Roychowdhury (2006) is used for evaluating the relationship between
managerial overconfidence and real earnings management. The study population consists of 1,144
observations and 143 firms listed on TSE over an eight-year period between 2008 and 2015. The statistical
model used in this paper is a multivariate regression model; besides, the statistical technique used to test the
hypotheses is panel data.
Findings – Consistent with the expectations, the results showed that there is a negative relationship between
managerial overconfidence and conditional conservatism. Furthermore, the findings suggest that managerial
overconfidence is negatively connected with real earnings management. This implies that when Iranian
managers have many financial problems, they do not engage in real earnings management, as the real earnings
management does not increase the value of the companies in the long run and even it cause damage to them.
Originality/value – This is one of the most important research that simultaneously surveys the impact of
managerial overconfidence on conditional conservatism and real earnings management in a developing market
called Iran. What really sets this study apart from other papers is that most Iranian firms between 2008 and 2015
because of economic sanctions faced severe financial problems. From this perspective, this study contributes to
the research literature by expanding the knowledge of conservatism in the emerging economies.
Keywords Managerial overconfidence, Conditional conservatism, Real earnings management,
Tehran stock exchange
Paper type Research paper
1. Introduction
Overconfident managers overestimate the future returns resulting from the investment of
the firm (Heaton, 1997). In other words, overoptimistic managers tend to overestimate the
mean of future cash flow and underestimate the volatility of future cash flow. Previous Effect of
research reports that overconfidence affected on firm’s investment, financing and dividend managerial
payout policy (Malmendier and Tate, 2008; Cordeiro, 2009; Deshmukh et al., 2009;
Malmendier et al., 2011; Hirshleifer et al., 2012).
overconfidence
The main role of financial reporting is the effective transfer of financial information to
outsiders in a credible and timely manner that provides the necessary information to
evaluate the performance of an enterprise. A prerequisite for achieving this goal is providing
financial information in a way that makes it possible to evaluate past performance, and also 709
is effective in the assessment of future profitability and predicting business activities.
Conservatism is one of the financial reporting characteristics that has attracted more
attention in recent years because of financial scandals in companies such as Enron and
WorldCom. So that some recent studies such as Watts (2003) and Roychowdhury and Watts
(2007) have focused on the issue of conservatism. Clearly, one of the qualitative features of
accounting information is conservatism. The qualitative characteristics of accounting
information have an undeniable role in improving the quality of financial statements. In this
regard, Watts (2003) suggests that accounting conservatism is an important feature of
improving the quality of accounting information. On the other hand, earnings management
is defined as the process of taking conscious steps within the range of generally accepted
accounting principles (GAAP) to close the reported profits to the desired profit level. Healy
and Whalen (1999) suggested that earnings management is conscious behavior that is used
to reduce the periodic fluctuations of profits. In fact, earnings management occurs when
managers use “judgment” in financial statements to influence shareholders’ perceptions and
insights into the company’s economic performance by distorting financial statements.
Apparently, managers often manage profits so as to mislead their stakeholders about the
company’s real economic performance. The earnings management, which is done by
manipulating accounting figures reduces the accuracy of earnings reports, and it also may
lead to information asymmetry and reducing investment efficiency. Earnings management
not only conceals a company’s true performance but also hides the real growth of corporate
profits that is useful in predicting the future growth of a firm (McNichols and Stubben,
2008).
As for Iran’s market, it can be mentioned that Iran’s country struggled with severe
economic sanctions during the study period between 2008 and 2015, and most Iranian
companies had financial distress. In such an economic environment, it is expected that
overconfident executives overestimate the likelihood and impact of favorable events on
corporate cash flows and underestimate the possibility of negative happenings on corporate
cash flows. This feature can affect the decisions made by executives regarding profit
smoothing. Hence, the first aim of this paper is to investigate whether there is a relationship
between earnings management and overconfidence management; and most importantly, if
there is a meaningful connection, how is the type of relationship? We also envisage that
probably because of the financial problems of firms, Iranian managers will accelerate the
identification of profits and delay identification of the companies’ losses, which is in
contradiction with the principle of conditional conservatism. Thus, we are going to know
whether overconfidence management leads to financial reporting based on less conditional
conservatism among companies listed on the Tehran Stock Exchange (TSE).
The rest of the aforementioned study is organized as follows: Section 2 frames the study
into a theoretical framework, hypotheses development and literature. Section 3 shows the
research design and outlines where data is obtained and the sample selection procedure.
Section 4 then presents the main results and implications drawn from statistical analysis
and. Finally, Section 5 presents the concluding remarks.
JIABR 2. The theoretical framework, hypotheses development and literature
11,3 Overconfident managers overestimate future returns that are derived from their firm’s
investment projects. These directors are of the opinion that their companies’ securities are
underrated, either because they think cash flows from current projects to be higher or
because they predict better future growth opportunities (Cordeiro, 2009). Hence, they likely
have a tendency to delay recognition of losses and useless the conditional conservatism in
710 accounting. For example, a poor project with negative net present value (NPV) may be
considered as a project with positive NPV by those managers who are a bit full of themselves,
which leads to delays in identifying the losses of the project (Malmendier and Tate, 2005;
Ahmed and Duellman, 2013). Cordeiro (2009) also showed there is a negative association
between managerial overconfidence and the extent of dividends and total distributions paid out
to stockholders. In another research, Deshmukh et al. (2009) proved that the extent of the
affirmative market reaction to a dividend-increase announcement is lower for companies
managed by overoptimistic chief executive officers (CEOs). In fact, both scholars concluded
that arrogant managers who are sure of their financial knowledge compared to other
executives, tend to pay lower dividends. In a developed country called America, Adam et al.
(2015) surveyed the impact of managerial overconfidence on corporate risk management. Their
studies saw a positive connection between managerial overconfidence and risky decision.
Generally, speaking, managerial estimates play a critical role in applying conservative
accounting. For example, managers evaluate the inventory of a firm based on the value of
lower of cost or market; moreover, they often overrate future returns from their firm’s projects.
It should be noted that the overestimation of future returns or cash flows from current projects
or assets has at least two implications for managers’ accounting decisions. Firstly, managers
are more likely to accelerate the identification of profits and delay the recognition of losses. In
addition, when they decide to identify losses, it is likely that the magnitude of these losses will
be underestimated. Thus, one can expect that when overconfidence exists, the conditional
conservatism in accounting will be decreased (Ahmed and Duellman, 2013).
With respect to accounting conservatism, it can be mentioned that conservatism has
many advantages such as improving managerial decisions and reducing agency problems
(Watts, 2003; Ball and Shivakumar, 2005; Hwang et al., 2015). There are two types of
conservatism, namely, conditional and unconditional (Iatridis, 2011). Conditional
conservatism is a type of conservatism that is required by GAAP; that is, earnings reflect
the bad news faster than good news, which resulted in the more timely recognition of losses
(Beaver and Ryan, 2005). As a matter of fact, this type of conservatism is called retrospective
conservatism; whereas unconditional conservatism is not required by GAAP, and, as it
shows the net book value of assets lower than the actual value is known as prospective
conservatism (Bani Mahd and Baghbani, 2010). To demonstrate the positive effect of
conditional conservatism on the quality of financial reporting, it is necessary to refer to Lee
and Sami’s studies in 2014. They using a sample of firm-year observations over the period of
2004-2009 in the America market realized that conditional conservatism in accounting can
decrease the amount of audit risk and audit fees. However, their evidence displays that this
reduction in the volume of audit fee is moderated by higher corporate governance quality. In
the UK market, Iatridis (2011) believed that high-quality disclosers display greater
conditional conservatism and less unconditional conservatism.
It should be noted that managerial overconfidence may have a direct relationship with
conservatism. Hwang et al. (2015) examined a sample of 11,906 firm-year observations of
Korean listed companies from 2003 to 2011 and concluded that there is a negative
relationship between managerial overconfidence and conditional conservatism. Similarly,
Ahmed and Duellman (2013) using 14,641 firm-years from 1993 to 2009 forecasts that
overconfident managers tend to delay loss recognizing and in general have lower Effect of
conditional conservatism. They also examined whether external control mechanisms managerial
leading to alleviate the negative impact of overconfidence on conservatism in financial
reporting? To measure the conservatism in accounting, they use conditional and
overconfidence
unconditional conservatism. Their findings showed that there is a significant negative
relation between overconfidence and both conditional and unconditional conservatism.
They also concluded that external control mechanisms could not lead to alleviating the
negative impact of managerial overconfidence on conservatism in financial reporting. With
711
a review of recent research on the Iranian market, we find that managerial overconfidence
has a negative effect on accounting conservatism. For instance, Ramsheh and Molanzari
(2014) evaluated the relation between managerial overconfidence and accounting
conservatism. They found that there is a negative relationship between managerial
overconfidence and both the conditional and unconditional conservatism. Furthermore, their
findings indicated external monitoring appears to mitigate the negative effect of
overconfidence on conditional conservatism but does not appear to have the same effect on
unconditional conservatism. In another study, Foroghi and Nokhbeh Fallah (2014) examined
the impact of managerial overconfidence on conditional and unconditional conservatism
among companies listed on TSE during the years of 2002-2011. Their outcomes showed the
existence of overconfidence in the top executive’s results in decreasing of financial reporting
conservatism. Given the results obtained from past research, it is expected that, as Iranian
firms had severe financial problems owing to economic sanctions during the study period
between 2008 and 2015, Iranian overoptimistic managers have great motivation to
overestimate the mean of future cash flow and underestimate the volatility of future cash
flow to better demonstrate their companies’ performance. Consequently, we envisage that
the first hypothesis in this paper to be as follows:

H1. There is a negative relationship between managerial overconfidence and

conditional conservatism.
The concept of earnings management has been investigated from various angles and
various definitions have been presented so far. From Healy and Wahlen (1999) point of view,
earnings management occurs when managers use personal judgments in financial reporting
and transaction structures. Generally, earnings management means the management’s
conscious action on how to report a profit to meet specific objectives in a manner consistent
with accounting procedures. Obviously, earnings management is possible in two ways as
follows: profit management based on accounting figures and real profit management. In the
first instance, managers use discretionary accruals to make accounting figures consistent
with their goals. In the latter case, management manages real activities to achieve its desired
profit. Roychowdhury (2006) believes that although real profit management helps the
manager in achieving financial reporting’ goals, it does not increase the value of the
company. To put it another way, managers by doing such activities can achieve their short-
term gains but they will not be able to increase the value of the company in the long run.
Generally, when directors manipulate profits through actual activities, they usually cause
damage to the company. First of all, when managers manipulate profits, the contracts
require the company to give them more financial rewards. Secondly, the time and energy
that executives spend on manipulating real activities are often at the same time and energy
that should be spent on productive and profitable activities. Thirdly, the results of Bar-Gill
and Bebchuk’s (2003) research in 2003 showed that manipulating real activities would lead
to real economic costs.
JIABR Overconfident managers because of the belief that they have specific information that
11,3 others do not have, overestimate the accuracy of their information, and consequently, their
future corporate earnings and cash flows; besides, they have a positive outlook on future risk
and returns. Assuredly, earnings management is significantly influenced by expectations
about future profits and overconfident management affects these expectations. Over-optimistic
executives are likely to use the profits of future periods to increase the current period profits,
712 which means that these managers are more inclined to report higher profits than other
executives. Managerial overconfidence influences the smoothing of profits because of its
impact that has on estimating the future cash flows of the entity, which results in profit
management (Bouwman, 2014). Hsieh et al. (2014) found that corporate governance
mechanisms have a vital role in stopping the real earning management. Their results displayed
that before the Sarbanes Oxley Act of 2002, firms of overconfident CEOs were more likely than
other CEOs to engage in managing earnings by hurrying the timing of cash flow from
operations. After Sarbanes-Oxley Act, they found that overconfident CEOs are more likely to
have income-increasing discretionary accruals. Schrand and Zechman (2012) also reported that
managerial overconfidence influences the behavior of financial reporting. They showed a
positive relationship between the likelihood of fraudulent financial statements and
overconfidence; in addition, stronger internal and external governance mechanisms will not
reduce this impact. Likewise, Presley and Abbott (2013) concluded that there is a positive and
meaningful relationship between managerial overconfidence and financial restatements. After
that, Bouwman (2014) examined how managerial optimism affects earnings smoothing and
earnings surprise. His findings showed there is a positive and significant association between
earnings smoothing and managerial overconfidence. Actually, he proved that an optimistic
manager’s smooth earnings more than rational directors and are associated with smaller
earnings surprises. Farrell et al. (2014) provided evidence concerning the use of share
repurchases as an earnings management mechanism in the presence of debt-financing
constraints and the impact of these constraints on the use of accruals and other real earnings
management techniques. Their results witnessed a positive association between accruals-based
earnings management and financing constraints. They also indicated when firms are faced
with financing limitations, they avoid using real earnings management techniques.
In the Iran context, Hasani Alghar (2016) examined the relationship between managerial
overconfidence and industry specialist auditor using a sample of 71 firms listed on TSE
between 2008 and 2013. He inferred that overconfidence has no significant impact on using
the industry specialist auditor. In another study, Pourheidari et al. (2013) studied the effect of
real earnings management on investment behavior. They showed there is a positive
between real earnings management and inefficient investment. As previously mentioned,
the majority of Iranian firms because of economic sanctions had financial distress between
2008 and 2015. Therefore, we expect that when Iranian managers have financing
constraints, they do not engage in real earnings management because real profit
management does not increase the value of the company in the long run and even it cause
damage to the company (Roychowdhury, 2006). Broadly speaking, it is predictable that the
second hypothesis to be as follows:

H2. There is a negative relationship between managerial overconfidence and real

earnings management.

3. Research methodology
Because the results can be used in the decision-making process, this study is applied
research (Salehi et al., 2018). The statistical model used in this study was a multivariate
regression; the time range of the study was (2008-2015) as long as eight years. Post- Effect of
event research methodology is used for research that trying to investigate the cause or managerial
causes of certain relationships, which have occurred and completed in the past. This
type of research method has relatively high credibility because it seeks to achieve a
overconfidence
causal relationship between research factors. In this type of research, the possibility of
manipulating variables by researchers or creating artificial or laboratory conditions
because of various reasons is not possible. Our research is correlation research in terms
of its implementation method. In this study, the hypotheses are analyses based on 713
pooled/combined data.
The present study uses the combined data method; this technique (panel/combined) that
combined time-series data and cross-sectional data, it is widely used by researchers. This
method is used for cases where issues cannot be investigated in time-series and cross-
sectional or when the number of data is low. Integration of time-series and cross-sectional
data and the need for using them more likely is because of increasing the number of
observations, raising degrees of freedom, reducing heteroscedasticity of variance and
decreasing collinearity between variables.

3.1 Population and statistical sample

The statistical population of the study is all companies listed on TSE during the period
2008-2015. In this research, a systematic elimination method will be used to determine the
sample size based on the following criteria:

the financial periods of companies should be finished at the end of the solar year
(March 20) to enhance the comparability and homogeneity of companies in terms of
the time period;

the company should not have change fiscal year during the study period;

according to the research time period (2008-2015), the company is listed on the TSE
before the year 2008 and its name is not removed from the listed companies by the
end of 2015; and

the type of the business activity should be productive, and thus, investment
companies, leasing, credit and financial institutions and banks are not included in
our sample because of these companies have quite different natures in terms of
reporting and ownership structure (Salehi et al., 2017, 2018).

Taking account of the above conditions, a sample size of 143 companies from firms listed on
TSE has been selected.

3.2 Variables
Regarding the Model 1, it can be described that AAC is defined as a proxy for conditional
conservatism in accounting. In fact, AAC is a dependent variable for the Model 1, and total
accruals (ACC) equal to net income minus operating cash flows for firm i in fiscal year t
deflated by beginning-of-year total assets. OVERCON is equal to 1 if the capital
expenditures deflated by total assets at the beginning of the period is greater than its
median level for the relevant industry in that year, otherwise 0. CFO is operating cash flows
for firm i in fiscal year t deflated by beginning-of-year total assets. DCFO is an indicator
variable that equals 1 if operating cash flows for firm i at the end of the financial period is
negative, and otherwise 0. DREV is defined as the change in total revenue from deflated by
firm i in fiscal year t by ending of year total assets. Leverage is the sum of long-term debt
and current liabilities deflated by total assets at the end of the year. LN Assets is the natural
JIABR log of total assets at the end of that year. MTB equals the market value of equity divided by
11,3 the book value of equity at the end of the year t. Finally, ID is the industry dummy indicator
(Hwang et al., 2015).
With respect to the variables of Model 2, it can be explained that real earnings is
defined as a dependent variable, and it measured as deviations from the predicted
values from the corresponding industry-year regression CFOt/Asset t1 = a0 þ a1 (1/
714 Asset t  1) þ b 1(Salest/Asset t  1) þ b 2 (DSalest/Asset t1) þ « (Roychowdhury,
2006). Moreover, LNEMP is equal to the natural log of the total number of the
company’s employees. ROA is the ratio of net income to total assets and ROE means the
return on equity. LOSS is an indicator variable that is equal to 1 if the ROA is negative
and 0 otherwise. BIND is equal to the number of non-executive members of the board
divided by the total number of members of the board of directors. Ownership
concentration (OC) is the percentage of shares owned by a major shareholder that holds
more than 5 per cent of the company’s shares.

3.3 Research models

Looking at the past research, we find that there are various measures of overconfidence,
which have used by different researchers (Malmendier and Tate, 2005; Ben-David et al.,
2010; Campbell et al., 2011; Schrand and Zechman, 2012; Hirshleifer et al., 2012). As
mentioned before, Iranian overconfident managers had many financial problems because of
economic sanctions. It seems that an appreciate investment decision can help them to
improve their corporate situations. According to the opinions of Ben-David et al. (2010) and
Malmendier and Tate (2005), there is a significant association between corporate investment
decisions and managerial overconfidence. In short, we believe that in a bad economic
situation, an overconfident manager tries to overinvest in capital projects because he/she is
too optimistic about the future firm. Thus, we prefer to follow Ben-David et al. (2010) and use
a measure of overconfidence based on investment decisions as this approach is much closer
to the purpose of our study.
In Model 1, to examine the effect of moderating overconfident management on
conditional conservatism, Ball and Shivakumar’s (2006) model is used as follows. The most
important point concerning this model is that if the coefficient of b 7 is significant, the H1
will be significant:

ACCi;t ¼ b 0 þ b 1 CFOi;t þ b 2DCFOi;t þ b 3 DCFOi;t * CFOi;t þ b 4 OVERCONi;t

þ b 5 OVERCONi;t * CFOi;t þ b 6 OVERCONi;t * DCFOi;t
þ b7 OVERCONi;t * DCFOi;t * CFOi;t þ b 8 Leveragei;t
þ b 9 CFOi;t * Leveragei;t þ b 10 DCFOi;t * Leveragei;t
þ b 11 DCFOi;t * CFOi;t * Leveragei;t þ b 12 LNAssets;t þ b 13 CFOi;t * LNAssetsi; t
þ b 14 DCFOi;t * LNAssetsi;t þ b 15 DCFOi;t * CFOi;t * Total Asseti;t þ b 16 MTBi;t
þ b 17 CFOi;t * MTBi;t þ b 18 DCFOi;t * MTBi;t þ b 19 DCFOi;t * CFOi;t * MTBi;t
þ RIDi;t þ « i;t

In Model 2, to examine the relationship between overconfidence management and real

earnings management, Raychaudhuri model (2006) is used as follows:
 Real Earningsit ¼ a0 þ a1 OVERCONit þ a2 LNAssetit þ a3 LNEMPit þ a4 LEVit Effect of
þ a5 ROAit þ a6 LOSSit þ a7 MTBit þ a8 ROEit þ a9 BIINDit managerial
overconfidence
þ a10 OCit þ a11 Indastryit þ « it

4. Results 715
4.1 Descriptive statistics
The descriptive statistics display values of dispersion and central indices. The information
about the descriptive statistics is a phase towards understanding the mean data procedure
and the correlation between them, as well as examining the distribution status. The
descriptive results of this study include mean, median, standard deviation, minimum and
Maximum of observation, which is presented in the below table.
In Table I, in relation to the dependent variables, which used in this study could be seen
the mean of conditional conservatism variables are 0.31, 0.174 and 0.106 and the mean of
real earnings management is 0.10. Managerial overconfidence in sample companies is on
average 0.536. The mean of the size of the company is 13.708 and the natural logarithm of
employees is 6.117 on average. Moreover, the mean of financial leverage, company growth
and return on assets are 0.615, 2.404 and 0.196, respectively. Almost, 85 per cent of
companies have report loss. The average return on equity is 1.058. In relation to corporate
governance variables, which used in this study, board independence (BIND) and OC have
the means 0.658 and 0.806, respectively. It should be noted that a slight difference between
mean and median, as well as lack of high dispersion in variables, implies normal
distribution.

4.2 Conclusive statistics

Panel data indicates a data set based on which observations are examined by a
large number of sectional variables often selected randomly during a given period. Because
the panel data comprise both aspects of time series data and sectional ones, using
appropriate statistical explanatory models whose describe the specifications of the variables
is more difficult than the models used in sectional and time series data (Salehi et al., 2018).

Variables Observations Mean Median SD Max Min

ACC 1,145 0.031 0.006 0.205 2.134 0.885

CFO 1,145 0.174 0.123 0.208 0.914 0.427
DCFO 1,145 0.106 0 0.308 1 0
RE 1,145 0.010 0.002 0.304 1.831 1.857
OVERCON 1,145 0.536 1 0.498 1 0
LNAssets 1,145 13.708 13.566 1.440 19.009 9.880
LNEMP 1,145 6.117 5.945 0.995 10.016 3.465
LEV 1,145 0.615 0.620 0.212 1.938 0.090
MTB 1,145 2.404 1.960 1.728 8.967 0.061
ROA 1,145 0.196 0.133 1.012 0.928 0.602
LOSS 1,145 0.085 0 0.279 1 0
ROE 1,145 1.058 0.325 1.982 9.912 0.795 Table I.
BIND 1,145 0.658 0.600 0.204 0.851 0 Descriptive statistics
OC 1,145 0.806 0.851 0.160 1 0 of research variables
JIABR 4.3 F-Limer test
11,3 In the initial step, the F-Limer test is used for the sake of identifying whether the model is
fitted to the ordinary least squares (OLS) or panel data method. The null hypothesis (H0)
displays that there is no difference between the estimated coefficients for individual cross-
section and the estimated coefficient for individual mass. This implies that there is no
necessity to estimate the model by using the panel data (Salehi et al., 2018). Given the results
716 obtained, it was determined that the values of the statistics of the F-Limer test for the
hypotheses one and two equal 2.06 and 1.84, respectively. As the probability value of the H0
is less than 0.05, the preference of the OLS method is rejected for both hypotheses, while the
panel data methods are accepted.

4.4 Hausman test

After confirming the use of the panel data method, the Hausman test is used to decide
whether a panel data with fixed effects should be used or a panel data with random effect
(Salehi et al., 2018). This test is formed based on the presence or absence of a correlation
between the error of the regression and independent variables. Random effects model will
apply if such a relationship exists, and if it does not, the fixed effects model will be used. The
statistic of the test will have a chi-square ( x 2) distribution with k1 degrees of freedom if the
calculated chi-square statistic is greater than the critical value. This means that the p-value
of the test is less than 5 per cent, in this case, H0 is failed to accept, and the fixed effects
model is superior to the random effects model. The figures obtained showed that, as a p-
value of H0 for Model 1 is less than 0.05, Model 1 will be a model with fixed effects.
However, as a p-value of H0 for Model 2 is 0.370, a model with random effects will be
implied.

4.5 Lagrange multiplier test

Before launching a panel method with fixed or random effects, it is necessary to
examine whether it is possible to integrate time and space factors into a model. To
prove this case, the Lagrange multiplier (LM) test has been used by Breusch and Pagan.
According to the values of chi-square and the amount of p-value resulted from the
Pagan LM method, we can conclude that there are cross-sectional effects and there are
no time effects for both models.

4.6 Heteroskedasticity and autocorrelation of residuals

If there is panel data with fixed effects, likelihood ratio test (LRT) test will be used for
investigating heteroskedasticity. By contrast, if there is a panel data with random effects,
adjusted Wald chi-square test will evaluate the heteroskedasticity. In Model 1, as the p-value
for LRT test is less than 5 per cent, therefore, the H0 based on lack of heteroskedasticity
among the disturbing elements will be rejected. As a result, the error terms have
heteroskedasticity. In Model 2 because the p-value for the Wald test is less than 5 per cent,
H0 will not be accepted; as a consequence, the error terms have heteroskedasticity.
Additionally, the Durbin–Watson test is used for investigating the absence of serial
autocorrelation. A delicate point is that when the results of the Durbin–Watson test is
between 1.5 and 2.5, it can be concluded that the error terms do not have serial
autocorrelation. The values of the Durbin–Watson test for Models 1 and 2 are 2.11 and 1.67,
in turn, so there is serial autocorrelation among the error terms. To tackle the problem of
heteroskedasticity and serial autocorrelation and also to estimate model parameters more
appropriately, the generalized least squares method is used.
 In Table II, the value of the coefficient of determination indicates that independent and Effect of
control variables account for 61 per cent of conservative changes. The significance of the F- managerial
statistic (9/91) indicates the overall significance of the model related to the H1 of this
research. According to the t-statistic at the significance level of regression coefficients and
overconfidence
signs of coefficients of B7 variable can be concluded that managerial overconfidence has a
significant negative relationship with conditional conservatism in accounting. Thus, the H1
will be accepted at a confidence level of 95 per cent. The evidence witnessed in spite of the
717
fact that there is no significant connection between corporate growths (MTB) and
conservatism when firms have more financial leverage, the less use the conditional
conservatism in financial reporting. Besides, we found that larger firms often use more
conditional conservatism compared to smaller ones.
Given the results obtained from Table III, it is clear that the coefficient of determination
stating that the independent and control variables explain 3.6 per cent of real earnings
management. The significance of F-static represents the overall significance of the model
related to the H2 of the research. Based on the sign of the coefficient of the independent variable
(OVERCON) can be concluded that managerial overconfidence has a significant negative
relationship with real earnings management. Thus, the H2 will be accepted at a confidence
level of 95 per cent. In relation to controlling variables used in the model, the company’s loss
and OC have a significant positive correlation with real earnings management; however, there
is a significant and negative relationship between company growth and real earnings
management. Looking at the details of the table above, we also can find that there is no
significant relationship between other variables and real earnings management.

Variable Coefficient SD t-static p-value

C 0.016935 0.089695 0.188808 0.8503

CFO 0.362628 0.216114 1.677945 0.0937
DCFO 0.764569 0.175909 4.346392 0.000***
DCFO*CFO 9.479996 1.973674 4.803224 0.000***
OVERCON 0.006054 0.009229 0.655989 0.5120
CFO*OVERCON 0.033720 0.038399 0.878143 0.3801
DCFO*OVERCON 0.019722 0.023987 0.822204 0.4112
DCFO*CFO*OVERCAN 0.523930 0.245752 2.131944 0.0333**
TOTAL ASSET 0.013367 0.006233 2.144477 0.0322**
CFO*TOTAL ASSET 0.019934 0.014567 1.368427 0.1715
DCFO*TOTAL ASSET 0.038888 0.012021 3.234971 0.001***
TOTAL ASSET*CFO*DCFO 0.608024 0.149280 4.073036 0.000***
LEV 0.253013 0.033025 7.661163 0.000***
CFO*LEV 0.172257 0.090305 1.907495 0.0567*
DCFO*LEV 0.236326 0.056420 4.188697 0.000***
DCFO*CFO*LEV 2.310113 0.939584 2.458655 0.014**
MTB 0.002864 0.002720 1.053254 0.2925
CFO*MTB 0.012289 0.008736 1.406661 0.1598
DCFO*MTB 0.007350 0.008293 0.886330 0.3757
DCFO*CFO*MTB 0.022308 0.092662 0.240751 0.8098
INDUSTRY YES
Coefficient of determination 0.619
F-statistic 9.91
Table II.
Significance level 0.0000 The results of the
final fit of the
Notes: *** and ** denotes significance level at 99% and 95% respectively Model 1
JIABR Variable Coefficient SD t-statistic p-value
11,3
C 0.116021 0.237382 0.48875 0.6251
OVERCON 0.034057 0.008322 4.09219 0.000***
LNAsset 0.02234 0.017864 1.25057 0.2113
LNEMP 0.017493 0.023288 0.75118 0.4527
LEVARAGE 0.057534 0.052428 1.09738 0.2727
718 MTB 0.012051 0.005315 2.26725 0.0236**
ROA 0.002245 0.005617 0.39962 0.6895
LOSS 0.163163 0.04873 3.34832 0.0008***
ROE 0.009976 0.007686 1.29801 0.1945
BIND 0.081731 0.052455 1.55811 0.1195
OC 0.096179 0.049766 1.93261 0.0535*
Coefficient of determination 0.030
Table III. F-statistic 3.617
The results of the Significance level 0.000
final fit of the
Model 2 Notes: ***, ** and * denotes significance level at 99%, 95% and 90% respectively

5. Conclusion
The main objective of this study was to investigate the effect of managerial overconfidence on
conditional conservatism and real earnings management among companies listed on TSE
during the period 2008-2015. The H1 suggests that managerial overconfidence has a
moderating effect on conditional conservatism. According to the results, it was found that the
managerial overconfidence variable has a negative and significant relationship with
conditional conservatism; hence, the H1 is accepted at 95 per cent confidence level. To put it
another way, Iranian overconfident managers use less conditional conservatism in accounting
reports. Our results are consistent with the findings of Hwang et al. (2015), Ahmed and
Duellman (2013), and also with the studies of Ramsheh and Molanzari (2014) and Foroghi and
Nokhbeh Fallah (2014) in Iran market. Furthermore, our findings showed a negative
relationship between corporate financial leverage and conditional conservatism, whereas their
company size is positively linked to conditional conservatism. We also observed that company
growth has not a significant relationship with conditional conservatism.
In the second step of this paper, we investigated the impact of managerial overconfidence on
manipulating profits through real activities. The results of this study showed that
overconfidence has a negative and significant relationship with conditional conservatism in
accounting. The results of our study are in accordance with Pourheidari et al. (2013) and Farrell
et al. (2014), while the research of Bouwman (2014) is not the same. As regards the control
variables used in the model, it can be said that the company’s loss and OC are positively
connected with real earnings management. Nonetheless, company growth leads to decreasing
the volume of real earnings management.
What really fascinates other researchers about our paper is that the time period under
study is very unique because of the many financial problems experienced by Iranian
companies. Without any exaggeration, this research will make aware investors and
stakeholders of this fact that managerial overconfidence might be effective in reducing the
agency problems in emerging markets, particularly those markets struggling with financial
sanctions like Iran. Next, this paper will make users of financial statements aware of the
effect of overconfidence on accounting conservatism, so that they can make a better
valuation of financially impoverished firms.
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Further reading
Deshmukh, S., Goel, A. and Howe, K. (2013), “CEO overconfidence and dividend policy”, Journal of
Financial Intermediation, Vol. 22 No. 3, pp. 440-463.
Lee, H.S., Li, X. and Sami, H. (2014), “Conditional conservatism and audit fees”, Accounting Horizons,
Vol. 29 No. 1, pp. 83-113.

Corresponding author
Mahdi Salehi can be contacted at: mehdi.salehi@um.ac.ir

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