Disclosure versus Recognition: Inferences from Subsequent Events

• In Event: Eclectic Topics

Abstract

Standard setters explicitly state disclosure should not substitute for recognition in financial reports. Consistent with this directive, prior research shows investors find recognized values more pertinent than disclosed values. However, it remains unclear whether reporting items are recognized because they are more relevant for investing decisions, or whether the recognition of items itself focuses investor attention to these items. Understanding if and how the presentation format of an accounting item affects its use has important regulatory implications, especially as the volume of disclosure in financial reports continues to grow. Using the context of subsequent events, I identify the differential effect of disclosure versus recognition in a setting where the accounting treatment of an item is exogenously determined. I find market prices are more sensitive to recognized values than disclosed values for firms reporting on the same or similar events. I fail to find support for the hypothesis that this difference is due to differential reliability of disclosed and recognized values. Instead my results indicate that users of financial reports fixate on recognized items while failing to fully incorporate disclosed items into prices. This finding is consistent with disclosed values requiring more effort or expertise to understand and use.

Author

• Jeremy Michels, University of Colorado at Boulder