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Characteristics of Percentages Used in Sensitivity Disclosures, and Their Effect on Investors’ Judgments

Fri, October 4, 1:45 to 3:15pm, TBA

Abstract

We examine how managers’ choices of the magnitude and complexity of the percentage of hypothetical input change used to describe the estimated item’s sensitivity can affect investors’ perceptions of the reported item’s credibility. In our experiment, we manipulate the magnitude and the complexity of the hypothetical percentage change used in the two-sided sensitivity disclosure for a firm’s capitalized software development asset. We predict and find that investors will perceive the reported value of an estimated accounting item to be less credible when the related sensitivity disclosure uses a larger percentage of change but that the effect of the larger percentage will be greater when the percentage of change is more complex. Our prediction is based on our expectation that investors will find the sensitivity disclosure to be more meaningful when the percentage depicted in the disclosure is more complex; and therefore, they will be influenced more by the magnitude of a complex percentage used in the sensitivity disclosure. Our results confirm these expectations and contribute to our understanding of how investors process management communications, and highlight the role of discretion in financial disclosure requirements.

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