Can Investors Fully Adjust for Known Biases in Manager Communications?
Managerial communications often contain biased information because of managerial incentives and other influences. A common assumption in the accounting literature is that if investors are aware of the biases in managerial communications, they will be able o fully adjust for those known biases. Drawing on insights from several areas in psychology and accounting, we posit and experimentally test the idea that investors will be able to fully adjust for known biases in managerial communications only when the information about bias is precise (in quantitative form) and the investor’s judgment is compatible with that bias information (also in quantitative form). Results from three experiments reveal that even these conditions are not completely adequate for investors to unravel managerial bias for investors’ judgments about future earnings although they do appear adequate for their decisions about investing. We attribute these asymmetric results to investors giving the benefit of the doubt to firms for their seemingly biased forecasts of future earnings, but not giving them the benefit of the doubt when it pertains to their investment decisions. Our study has implications for researchers, firm managers, regulators, and investors.