An Experimental Approach to Assessing the Quantitative and Qualitative Compatibility Management Bias of Investment Managers

Abstract

Knowledge asymmetries and agency concerns among entrepreneurs, investors, and managers drive the natural evolution of the corporate information environment. Accounting data serves two main purposes in market-oriented economies. By supporting capital providers, like owners and creditors, in evaluating investment prospects and expected returns, accounting information primarily serves the ex-ante or valuation role. Second, accounting data enables capital suppliers to monitor the utilization of their invested capital. Firms frequently present distorted financial data. In this study, we propose and experimentally test the hypothesis that investors find it difficult to identify known biases in management's earnings forecasts, but they are more inclined to make a comprehensive adjustment when presented with quantitative bias information in EPS form, provided that the investor's evaluation aligns with the data. The findings of three experiments show that not all investors can detect managerial bias solely by compatibility and quantification. Furthermore, we show that this result holds even after accounting for other variables common in management earnings estimates. Our research benefits investors, regulators, and corporate leaders alike.