Connecting the Dots: Helping Investors Use Risk Disclosures When Evaluating Financial Statements

• In Event: Investor Response to Risk Indicators

Abstract

The SEC and other policy makers continually seek to improve the decision-usefulness of firm
risk factor disclosures. This study tests the impact of two related potential improvements on
investor judgments. First, we test the SEC’s recent requirement of a two-page summary of risk
factor disclosures, which was focused on increasing readability and reducing lengthy boilerplate
risk factor disclosures. Second, we propose and test hyperlinking financial statement line items
with related risk factor disclosures. This potential improvement is based on theories from
accounting and psychology that indicate such a change will facilitate greater causal coherence
when evaluating financial statements. We test both potential improvements in an experiment
with retail investors, and we find evidence that hyperlinking significantly affects investor
judgments and no evidence that the SEC's recent requirement to summarize risk factors impacts
judgments. A supplemental experiment further investigates the process of the hyperlinking
effect. These findings question the effectiveness of the SEC's recent requirement and provide a
new potential improvement for policy makers to consider.

Authors

• Michael Thomas Durney, University of Iowa

• James Smith, University of Lethbridge

• Mike Wynes, Wilfrid Laurier University