Fair Value Measurement Under High Uncertainty: The Effects of Disclosure Format and Management Aggressiveness On Users’ Risk Assessments

• In Event: Disclosures in Decision Making

Abstract

I examine the extent to which the high degree of inherent risk present in many fair value measurements (FVMs) is effectively communicated to financial statement users under conditions of high and low management aggressiveness. Specifically, I conduct an experiment that investigates which of three disclosure formats most effectively communicates the risk of high-uncertainty FVMs to users—a narrative sensitivity disclosure currently required in the U.S., a standard quantitative disclosure currently required under IFRS, or an “enhanced” disclosure I propose that also displays the impact of these changes on net income. Results of my study suggest that the standard quantitative sensitivity currently required under IFRS may have the unintended consequence of decreasing users’ risk assessments when management aggressiveness is high. Increased perceptions of trust, competence, and reliability upon receiving this disclosure partially explain this relationship. As predicted, however, the enhanced disclosure condition is more effective than the standard condition at communicating risk to users under conditions of high management aggressiveness. Thus, the additional information in the enhanced disclosure condition appears to counteract the tendency to decrease risk assessments, thus providing increased benefit to users at little incremental cost to preparers.

Author

• Nathan Hatch Cannon, Texas State University