Earnings management and financial distress or soundness determining CEOs’ future over- and under-investment decisions

Abstract

Abstract This study investigates the association between CEOs’ over-confidence in experiencing financial distress or soundness, future earnings management, and over and under-investment decisions. Specifically, it makes deeper the association between financial distress (soundness), requiring to increase (decrease) earnings management and over (under)-investment decisions. Methodologically, the authors demonstrate the CEOs’ aggressive behaviour in managing their firms’ earnings in developing countries. In other words, it shows a literature gap in some extant research that most CEOs in developing countries would intentionally manage future earnings for constructing future investment decisions. Then, it highlights that CEOs in developing countries tend to be over-confident because of cognitive distortion, assembling the earnings management to improve future performance. Finally, this study presents a newness with three critical reasoning arguments. First, this study uses the prospect theory, framing, conservatism and psychological projection to explain the CEOs’ future investment decisions due to past earnings information, which causes their behaviour to be more optimistic. Second, this research considers that financial distress or soundness influences the association between earnings management and future over(under) investment decisions. Third, this study investigates CEOs’ over-confidence using an international setting due to characteristic differentiation between advanced and developing countries, influencing this association.