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Review of Accounting Studies

Erschienen in:

05.08.2021

Manager perception and proprietary investment disclosure

verfasst von: Caleb Rawson

Erschienen in: Review of Accounting Studies | Ausgabe 4/2022

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Abstract

This paper investigates the role of manager perception in proprietary disclosure decisions. I find robust evidence that firms with overconfident CEOs (managers who are more likely to perceive proprietary costs to be lower) provide significantly more narrative R&D disclosures than firms without overconfident CEOs. In cross-sectional analysis, I find that this result is driven by observations where proprietary costs are more significant and salient. Consistent with R&D disclosures being proprietary, I find that the return on R&D is significantly lower when firms have more R&D disclosure and that this relation is not impacted by the presence of an overconfident CEO except through higher R&D disclosure. Finally, I find no association between having an overconfident CEO and nonproprietary disclosure. Collectively, these results suggest that manager perception of proprietary costs is an important determinant of firms’ voluntary proprietary disclosure.

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For example, disclosing that the firm is focusing efforts on a specific product line is likely useful for investors when valuing the firm. However, it is also information that peers will find useful when deciding where to focus their own R&D activities.

While each disclosure by overconfident CEOs is not inherently more (or less) proprietary than disclosures by non-overconfident CEOs, the fact that overconfident CEOs disclose more has, in turn, an association with the future return on R&D.

While management forecasts have been used as a proxy for proprietary disclosure (e.g., Li, 2010b; Huang et al. 2017), forecasts have also been used as a proxy for nonproprietary disclosure (e.g., Glaeser 2018) due to the intricate relation between disclosure and competition. When examining the association between overconfidence and proprietary disclosure, any measure of proprietary disclosure should provide information that competitors can act upon. Since forecasts aggregate performance to the firm level, they are unlikely to convey any specific piece of proprietary information, even though providing a forecast itself may be broadly considered proprietary.

Conversations with several anonymous patent attorneys confirmed that practitioners often view a patent as a strategic legal disclosure choice that is part of a broader patent “arms race.” This is partially due to patents providing less legal protection than is often assumed in prior academic research, as, for example, 74% of patentees lose if a patent is challenged in court (Allison et al. 2014).

Consistent with prior research (e.g., Schrand and Zechman 2012), this study treats narcissism as a distinct trait from overconfidence. While the two characteristics are distinct on both the construct and operational levels, psychology research has sometimes found that narcissism can lead to overconfidence in certain tasks (Campbell et al. 2004). However, narcissism is associated with many personal characteristics that overconfidence is not, such as attention seeking, exploitativeness, vanity, and a need for praise (Young et al. 2016). Thus, while an overconfident individual can also be narcissistic, not all overconfident individuals exhibit narcissistic tendencies.

Overoptimism may also be associated with CEOs’ perceiving the quality of underlying R&D to be different, leading to greater disclosure. Whether the hypothesized association is due to a direct or indirect effect, both represent systematically different perceived costs of disclosure conditional on underlying R&D.

One potential concern is that discretionary investment disclosures are often ex ante unverifiable. This can potentially create a “cheap talk” setting where investors perceive observed discretionary disclosure as managers hyping the firm. However, the presence of proprietary disclosure costs impacts this in two ways. First, if proprietary disclosure costs exist, managers will only disclose information if they perceive the benefits to be greater than the costs (Verrecchia 1983; Dye 1986). Second, managers will not disclose information unnecessarily (and hurt the firm), which allows for ex ante unverifiable disclosures to gain credibility (Gigler 1994).

While it is unlikely that individual managers have sole discretion over disclosures in the 10-K, prior literature has found that CEOs influence 10-K content (Hendricks et al. 2018) and are the ultimate decision makers for the firm, setting and influencing firm-wide policies and disclosure practices (e.g., Bochkay et al. 2019).

A common concern with “bag-of-words” based approaches is that they do not capture contextual meaning of the targeted words or phrases (Loughran and McDonald, 2016). This can be especially problematic when relevant words can play multiple parts of speech. For example, a sentence beginning “The firm met management plans for the year and increased R&D by…” contains historical information, while a sentence beginning “Management plans to increase R&D by…” contains nonhistorical information. However, both sentences would be classified as being forward looking by Muslu et al. (2015) and Li (2010a) due to containing “management plans”. My algorithm identifies “plans” as a noun in the first sentence and a verb (third-person singular present) in the second sentence; thus, it only classifies the second as containing nonhistorical information.

Untabulated analysis indicates that, on average, 69% of R&D disclosures are non-historical while only 24% are forward-looking utilizing the Li (2010a) measure. As validation of my algorithm, I manually read 250 random investment disclosures and classify whether they contain predominantly historical information. I find 91% agreement between the algorithm and my hand classified sentences.

While some prior literature (e.g., Chyz et al. 2019) uses 67% as the cutoff for overconfidence, I follow Campbell et al. (2011) and use the 100% cutoff for two reasons. First, the ExecuComp data is not as detailed as the data initially used by Malmendier and Tate (2005) to motivate the 67% cutoff, so I use 100% to limit the number of CEOs incorrectly identified as being overconfident. Second, to the extent that the 67% cutoff correctly identifies CEOs as being overconfident, using a 100% cutoff will identify CEOs who are even more overconfident.

See Hilary and Hsu (2011) and Hilary et al. (2016) for a discussion of dynamic overconfidence regarding management forecasting.

Daniel and Hirshleifer (2015) note that while individuals’ confidence levels can change as they receive feedback, this confidence revision is not symmetric, leading “people to treat successes as mainly a reflection of their own skills and failures as mainly a matter of bad luck” (p.77). This behavior of asymmetrically responding to feedback is related to overconfidence on a fundamental level and is often referred to as self-attribution bias (Daniel and Hirshleifer 2015) or interpretational bias (Kim et al. 2016).

The 10-K is not filed for several months after the end of the fiscal year, during which time CEO turnover can occur. I treat firms with CEO turnover in the two months after the fiscal year as having a non-overconfident CEO. The results are substantially unchanged if I exclude those observations.

I use a firm-specific proxy for competition for two reasons. First, a notable amount of prior literature has used the extent of R&D as a proxy for the firm operating in an environment with high proprietary costs (e.g., Albring et al. 2016). This is problematic, as the extent of R&D directly influences R&D disclosures. Second, industry measures are also common (e.g., Huang et al. 2017). However, for reasons unrelated to proprietary costs, the extent of investment disclosure may be markedly different between industries.

The positive association between Competition and R&D Disclosure indicates that firms with higher competition disclose more about R&D. This is largely due to the exclusion of non-R&D performing firms (which are more likely to have lower competition) and to firms being more likely to research when in need of a competitive advantage. In untabulated robustness tests, I include non-R&D firms and find no base association between Competition and R&D Disclosure while continuing to find a significant interaction. Further, I classify firms as having high competition when Competition is above the median during the year, and create a PSM sample matching on all determinants. This results in a sample of firms with high and low competition having similar R&D levels, and I continue to find that firms with overconfident CEOs provide more R&D disclosure when competition is higher.

A potential alternative explanation is that the firm is trying to “stake its claim” to ward off future competition. Various studies have found this type of behavior in the patenting arena (e.g., Glaeser and Landsman 2021). Within the patenting arena, claim staking is important as it provides a legal defense against future patent infringement. However, narrative R&D disclosures are unlikely to be the result of claim staking, as there is no legal recourse if the information is used by competitors (i.e., the “claim” has no legal protection or recognition).

The results in Tables 3 and 4 are robust to using an additional proxy of overconfidence based on firm decisions (Schrand and Zechman 2012; Kim et al. 2016). Section 5 further discusses several alternative proxies and results.

For brevity, analysis examining historical R&D disclosure is not tabulated in Tables 6 and 7. However, untabulated results are consistent with historical R&D disclosures having lower proprietary costs.

The number of observations is slightly lower in Tables 6 and 7 due to requiring information for the following three years. Results are robust to alternatively using continuous R&D Disc or looking at earnings over five years.

In untabulated robustness tests, I include a three-way interaction term between R&D, High R&D Disclosure, and Overconfident and find it to be insignificant, while the coefficient on R&D*High R&D Disclosure remains negative and significant.

Hirshleifer et al. (2012) find that, from 1993 to 2003, firms with overconfident CEOs have higher stock volatility. The results in Table 7 indicate that once conditioning on the presence of R&D (dropping non-R&D performing firms) and controlling for investment levels—something Hirshleifer et al. (2012) do not consider—there is not an association between having an overconfident CEO and earnings volatility.

For brevity, Tables 9 and 10 tabulate results only for total R&D disclosure. Untabulated analyses examining nonhistorical R&D disclosure are also consistent.

There are 555 turnovers in the sample where both the outgoing and incoming CEO were at the firm for at least two years, and 177 turnovers had a change in CEO overconfidence. I examine univariate changes in R&D disclosure in the years surrounding turnovers for this reduced sample. Firms moving from a non-overconfident to an overconfident CEO experienced a mean 28% increase in R&D disclosures from two years prior to the turnover to two years post turnover, while firms moving from an overconfident to non-overconfident CEO experienced a mean 14% increase over that same time period. This difference is statistically significant and is consistent with overconfident CEOs increasing R&D disclosure in the years after their arrival at a firm.

Data is acquired from Lalitha Naveen’s website: sites.temple.edu/lnaveen/data/. CEO delta is developed according to Coles et al. (2006), and firm-related wealth is developed according to Daniel et al. (2020).

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Titel: Manager perception and proprietary investment disclosure
verfasst von: Caleb Rawson
Publikationsdatum: 05.08.2021
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 4/2022
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-021-09629-1

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