How Do Investors Process Complex Accounting Estimates? Term Repetition Matters

• In Event: 3.02 Investor Judgment II

Abstract

Regulators require companies to provide explanatory disclosures (e.g., sensitivity disclosures) for complex accounting estimates, but often allow discretion in the terms used in these disclosures. We propose that whether managers use repetitive or non-repetitive terms in explanatory disclosures could affect investors’ processing of complex accounting estimates and their willingness to invest. In two experiments with different settings (a fair value estimation setting in Experiment 1 and a pension disclosure setting in Experiment 2), we manipulate (1) whether managers’ measurement choices in Level 3 fair value estimates or pension estimates are consistent or inconsistent with their incentives to boost reported earnings, and (2) whether managers use repetitive or non-repetitive terms in explanatory disclosures. We find that investors are more willing to invest when measurement choices are inconsistent versus consistent with managers’ incentives, but only when explanatory disclosures use repetitive terms rather than non-repetitive terms. Mediation analysis suggests that explanatory disclosures with repetitive terms increase investors’ credibility assessments when managers’ measurement choices are inconsistent versus consistent with their incentives, which in turn affects investors’ investment willingness. In contrast, we do not find such a mediation relationship for explanatory disclosures with non-repetitive terms. Our study provides important insights to accounting researchers, practitioners, and regulators.

Authors

• Ling Lin Harris, University of South Carolina

• Marlys Gascho Lipe, University of South Carolina

• Ying Wang, University of Massachusetts-Amherst