Background: Visual hallucinations (VH) are a common symptom in dementia with Lewy bodies (DLB); however, their cognitive underpinnings remain unclear. Hallucinations have been related to cognitive slowing in DLB and may arise due to impaired sensory input, dysregulation in top-down influences over perception, or an imbalance between the two, resulting in false visual inferences. Methods: Here we employed a drift diffusion model yielding estimates of perceptual encoding time, decision threshold, and drift rate of evidence accumulation to (i) investigate the nature of DLB-related slowing of responses and (ii) their relationship to visuospatial performance and visual hallucinations. The EZ drift diffusion model was fitted to mean reaction time (RT), accuracy and RT variance from two-choice reaction time (CRT) tasks and data were compared between groups of mild cognitive impairment (MCI-LB) LB patients (n = 49) and healthy older adults (n = 25). Results: No difference was detected in drift rate between patients and controls, but MCI-LB patients showed slower non-decision times and boundary separation values than control participants. Furthermore, non-decision time was negatively correlated with visuospatial performance in MCI-LB, and score on visual hallucinations inventory. However, only boundary separation was related to clinical incidence of visual hallucinations. Conclusions: These results suggest that a primary impairment in perceptual encoding may contribute to the visuospatial performance, however a more cautious response strategy may be related to visual hallucinations in Lewy body disease. Interestingly, MCI-LB patients showed no impairment in information processing ability, suggesting that, when perceptual encoding was successful, patients were able to normally process information, potentially explaining the variability of hallucination incidence.