We study the joint effect of CEO overconfidence and accounting conservatism on firmperformance and value. Successful innovation involves trial and error. An overconfident CEO is morewilling to initiate daring investment projects, but also subjects the firm to excessive risk. Accountingconservatism (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 beforethe project was undertaken. The theory of innovation, therefore, predicts that CEO overconfidenceand accounting conservatism are complementary, i.e., the presence of both biases improves the firm'sperformance relative to the baseline case, especially if the firm operates in a dynamic, fast-changingenvironment.
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