The Effect of Disclosure Readability and Education on Nonprofessional Investors’ Estimates of Stock Price and Management Credibility

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Abstract

Readability research suggests that individuals must possess a graduate education to read and understand current annual reports. In this paper, we address the question of whether increasing the readability of annual report risk disclosures to a level below graduate education impacts the equity valuation decisions of nonprofessional investors. Using 359 responses from an experimental survey of nonprofessional US investors, we find that education level significantly influences investors’ equity valuation estimates, regardless of readability. Investors with graduate degrees consistently provide lower estimates than investors with, at most, a bachelor’s degree. Further, we find that equity valuations of less-educated individuals are significantly lower when the disclosure is less readable than when it is more readable, but find no difference within more-educated investors. We explore interactions between education level and readability on perceptions of management credibility, (i.e., competence and trustworthiness). We find that low readability results in increased perceptions of trustworthiness among less-educated investors and decreased perceptions among more-educated investors. This implies that more-educated investors may be more skeptical of management using difficult-to-read language, but less-educated investors may actually reward management for difficult-to-read language. Overall, the effects of mandated readability on investor judgments appear to depend on other individual characteristics, and thus are not a panacea for improving corporate disclosures.

Authors

• Jennifer Riley, University of Nebraska-Omaha

• Eileen Z Taylor, North Carolina State University