The effect of managerial information biasing on a firm's cost of capital in an environment with multiple information sources: An experiment

Much of the behavioral research in accounting that examines how users react to information about a firm is conducted in experimental settings that include only signals provided by management. These signals are used to estimate future cash flows and determine the cost of capital. However, due to the normal incentives faced by management, users may suspect that these signals are biased.;This study examines how the presence of a signal from an outside source affects commercial loan officer (CLOs) estimates of bias in management signals and assessments of credit risk. In the experimental setting, CLOs receive a signal from either (i) management only; or (ii) management and an outside source (i.e., a source independent of management). After receiving the outside signal, CLOs are expected to adjust their perceptions of management's reporting strategy, which in turn may change their estimates of bias and credit risk. The results suggest that the presence of an outside signal helps CLOs classify management reports as (i) aggressive; (ii) unbiased; or (iii) conservative, and influences their assessments of (i) bias in management signals; and (ii) credit risk. Specifically, in an environment with no outside signals, CLOs: (i) perceive aggressive reporting, regardless of management's actual reporting strategy; (ii) estimate a bias that is much different than the actual bias in management's signals; and (iii) assign the lowest (highest) credit risk to aggressive (conservative) reporting. In an environment that includes outside signals CLOs: (i) perceive aggressive reporting only when management is aggressive; (ii) estimate a bias that approximates the actual bias in management's signals for both aggressive and unbiased reporting and, for conservative reporting, estimate a bias that differs from the actual bias in management's signal; and (iii) assign the same credit risk to each reporting strategy. This study is important because it shows that the economic consequences of management's reporting choice is a function of the information environment.;In real-world settings, users normally process signals from many sources. Signals from sources independent of management (i.e., financial analyst or industry newsletter) may provide information helpful in interpreting management's signals. For example, users may rely on outside signals to estimate bias in management's signals, which in turn may affect the firm's cost of capital.