۱- Introduction

۲- Literature review and hypothesis development

۳- Research methods

۴- Results

۵- Conclusion

References

Abstract

We investigate how overconfident CEOs and CFOs may interact to influence firms’ tax avoidance. We adopt an equity measure to capture overconfident CEOs and CFOs and utilize multiple measures to identify companies’ tax-avoidance activities. We document that CFOs, as CEOs’ business partners, play an important role in facilitating and executing overconfident CEOs’ decisions in regard to tax avoidance. Specifically, we find that companies are more likely to engage in tax-avoidance activities when they have both overconfident CEOs and overconfident CFOs, compared with companies that have other combinations of CEO/CFO overconfidence (e.g., an overconfident CEO with a non-overconfident CFO), which is consistent with the False Consensus Effect Theory. Our study helps investors, regulators, and policymakers understand companies’ decision-making processes with regard to tax avoidance.

Introduction

Overconfidence has been found to be a common personal trait among CEOs and may have an effect on CEOs’ investment decisions and financial reporting choices (Goel and Thakor, 2008). Upper Echelons theory suggests that organizational behaviors reflect the personal traits of top executives (Hambrick, 2016; Hambrick and Mason, 1984),1 and CEO overconfidence may play an important role in corporate policy setting and strategic decisions. The literature has shown that companies with overconfident CEOs are more likely to have higher-level investments (Brown and Sarma, 2007; Malmendier and Tate, 2005, 2008), more innovative activities, and greater innovation success (Galasso and Simcoe, 2011; Hirshleifer et al., 2012) relative to companies with non-overconfident CEOs. Overconfident CEOs also need stronger cash inflows as compared to non-overconfident CEOs to satisfy their investment and innovation funding needs (Richardson, 2006). Prior studies, however, also document that overconfident CEOs tend to overestimate their ability to generate earnings, which may create discrepancies between companies’ real performance and their earnings expectations, resulting in the management of financial results to meet their expectations and satisfy their confidence needs (Gilson, 1989; Hribar and Yang, 2016; Hsieh et al., 2014; Schrand and Zechman, 2012). Tax avoidance may serve as an effective earnings management tool for companies to meet their earnings target, while alleviating their tax burden and increasing cash flows (Desai and Dharmapala, 2009; Halon, 2005; Phillips et al., 2003). Therefore, overconfident CEOs are more likely to promote tax avoidance, which is reflected in lower corporate effective tax rates (Olsen and Stekelberg, 2015). Although the impact of CEO overconfidence on corporate decision-making processes is understood, it should be noted that CEOs may rely on CFOs to execute their financial reporting decisions (Jiang et al., 2010). Feng et al. (2011) also suggest that CFOs use their financial expertise to manipulate earnings because they succumb to pressure from CEOs for earnings management. Practitioners also recognize the importance of CFOs in financial reporting-related issues and call for closer scrutiny of the backgrounds and qualifications of CFOs who assist CEOs, as their business partners, in their decision-making processes (Cox, 2013; Egon Zehnder, 2016). AESC (2015) argues that CFOs should possess the right chemistry (e.g., matched personality traits and similar beliefs) to collaborate with CEOs for the most effective and efficient management of the company. This contention is consistent with the False Consensus Effect, a psychological theory posits that people tend to selectively expose themselves to those who possess similar personality traits and, thus, share similar beliefs and values (Bahns et al., 2017). This selective exposure may lead to a cognitive bias of judgmental consensus in a social environment and, thus, exaggerate the overconfidence effect in a social relationship for people who share similar personality traits (Aronson et al., 2015; Bauman and Geher, 2002). Following these arguments, we investigate whether companies are more likely to engage in tax-avoidance activities when they have both an overconfident CEO and overconfident CFO, relative to other CEO/CFO combinations as based on their overconfident personality traits.