The Role of Excuses in Investing into Information Quality

Abstract

We analyze a manager''s choice of precision of the information in a repeated cheap talk game under which the manager can excuse his lie by blaming the poor quality of the information system. In this setting, the manager can protect his reputation for the future period if the precision of information is imperfect, providing the manager with incentives to choose the poor quality of information system. However, the analyses show that even though the manager can excuse his lie relying on the imperfect precision, he finally selects perfect precision in most cases. The only exception is when he cannot publically determine the precision and he knows that his interest is not aligned with investor''s. Even in this case, he randomizes his choice of information quality between perfect and imperfect precision. Otherwise, the manager chooses the perfect precision of information system. Our theoretical model provides important insights into why managers provide truthful or precise disclosures in most cases even if they are able to lie. In addition, our findings explain why they sometimes deviate from their normal practice and provide inaccurate, biased, or imprecise forecasts.