Can Investors Adjust for Managerial Bias?

Abstract

Financial information from firms often contains biased information. A common assumption in the accounting literature is that if investors are aware of biases, they will be able to 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 best able to adjust for known biases in management’s earnings forecasts when the information about bias is in quantitative, EPS form and the investor’s judgment is compatible with that bias information (also in quantitative, EPS form). Results from three experiments suggest that quantification and compatibility are beneficial for unraveling managerial bias, but not all investors unravel even under these conditions. We also show that this result is robust to several moderator variables that capture factors that are commonly found in the management earnings forecast setting. Our study has implications for researchers, firm managers, regulators, and investors.

Keywords: Forecasts, Bias, Unraveling

JEL Classification: M41