We report the results of an experiment designed to examine the effect of opportunity to provide an explanation for inaccurate results and predictability of behavior on managers’ reporting bias and investors’ ability to decipher the bias. We conduct 20 experimental sessions, each comprised of one manager and three or four investors. The manager has an incentive, in general, to inflate investors’ expectations and investors have an incentive to accurately predict value. We find that the manager reports with an upward bias a majority of the time. The magnitude of the bias, however, is lessened considerably when the manager’s reporting behavior is unpredictable and the manager has an opportunity to explain inaccurate (biased) reports. The data suggest that under such conditions the manager seeks to avoid reporting inaccurately and having to choose an explanation. We also find that investors adapt to the manager’s behavior and, strikingly, anticipate that explanation dampens reporting bias.
Ackert, Lucy and Church, Bryan, "Explanation and Misrepresentation in the Laboratory" (2006). ExCEN Working Papers. 148.