Directional Preferences, Information Processing, and Investors' Forecasts of Earnings

37 Pages Posted: 20 Apr 2006

See all articles by Jeffrey Hales

Jeffrey Hales

University of Texas at Austin - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: April 2006

Abstract

This paper reports the results of an experiment showing that investors' forecasts of earnings are affected by the investment positions they hold and by whether they are facing the prospect of a gain or loss on those investments. The results are consistent with theories of motivated reasoning that predict when and in what manner directional preferences affect how information is processed. Specifically, investors unthinkingly accept information that implies a gain for their investment, but disagree with information that implies a loss. In addition to the asymmetry in when investors are skeptical of information, investors are also biased in how they disagree: long investors expect higher future performance and short investors expect lower future performance. These results have important implications for understanding not only investor behavior, but also the behavior of market participants who face conflicts of interest, such as analysts, managers, and auditors, by providing direct evidence that such behavior can arise for purely psychological reasons. By providing evidence on how information processing is affected, the findings suggest testable predictions for accounting "fixation" effects and for the association of price and forecast biases with the favorability of public information, market-wide short interest, forecast dispersion, and trading volume.

Keywords: Motivated reasoning, independence, optimism, forecast bias and dispersion

Suggested Citation

Hales, Jeffrey, Directional Preferences, Information Processing, and Investors' Forecasts of Earnings (April 2006). Available at SSRN: https://ssrn.com/abstract=896308 or http://dx.doi.org/10.2139/ssrn.896308

Jeffrey Hales (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States
512-471-2163 (Phone)
512-471-3907 (Fax)

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