When Beliefs Influence the Perceived Signal Precision: Information Provision Style and the Impact of News

Abstract

In a world of increasingly extensive information, rational investors can make better decisions. However, reinforcement-oriented investors are also more likely to observe preferred signals close to their own perception. A focus on these signals distorts the perceived aggregate signal in the direction of the prior estimate. This reduces belief adaptation. Hence, the empirically well-documented selective exposure / reinforcement theory reduces the impact of greater information availability on price efficiency. Additional information can sometimes even decrease perception correctness. In a market with biased investors, managers have an incentive to announce more, diffuse (fewer, precise) signals in case of negative (positive) information. This results in post-earnings-announcement drift and dispersion anomaly. Also, the distribution shape matters for information processing. For unimodal, symmetric distributions, agents' perceptions converge to the fundamental -- even though at a reduced speed. For multimodal signal distributions, the estimate can diverge from the fundamental.