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The Effect of a Cautionary Notice on Investors’ Reactions to More and Less Readable Disclosures

Sat, October 10, 10:30am to 12:00pm, TBA

Abstract

Managers use discretion over disclosure language in ways that appear to reduce the effect of bad news and/or amplify the effect of good news. We test how a cautionary notice highlighting management’s discretion over disclosure language affects investors’ reactions to more and less readable disclosures. We find that a cautionary notice causes investors to reduce their valuation judgments in response to more readable good news disclosures and less readable bad news disclosures. Further, tests of an original process model indicate that investors who receive a cautionary notice evaluate all disclosures more skeptically, regardless of readability, but a cautionary notice only decreases reliance on disclosures when language choices are consistent with management incentives to promote good news or obfuscate bad news. Our results should be informative to regulators, given their interest in both promoting more readable disclosures and protecting investors.

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