Examination and implications of experimental research on investor perceptions
Introduction
A vast field of literature is dedicated to understanding capital market reactions. Underlying this literature is the desire to understand how investor reactions are influenced by information. Many archival studies attempt to understand investors’ reactions through various proxies. This stream of literature is extremely valuable to our overall understanding of investor reactions. However, it is difficult to isolate and measure investor perceptions or the underlying cause of investor reactions using archival data.
There are four major issues that make it necessary to supplement archival studies with other methods. First is the issue of endogeneity. Information that is disclosed by a firm is a function of management’s expectations of investor reactions to the information. Accordingly, it is difficult to determine if disclosure is a function of expected investor reactions or if investor reactions are a function of the disclosure. It is difficult with archival data to isolate one firm aspect from all of the other aspects that can affect firm choices and performance. The second major issue facing archival studies is the difficulty of measuring events cleanly. Investors are oftentimes aware of impending changes within a firm or to accounting standards long before the changes are implemented, making it difficult to know when investors first learn of and react to changes. Interpretations of archival results are uncertain due to the necessary use of proxies, which leads to the third major issue: Proxies are noisy measures that can suffer from low construct validity. See Healy and Palepu (2001) for a comprehensive archival literature review and discussion of these issues. Lastly, archival research relies on the existence of data, so it is not useful for ex-ante research.
Experimental research on investor perceptions has grown over the last few decades to attempt to address these concerns. Fig. 1, Fig. 2 show a marked increase over the years in publications that use experimental methods to examine investors. As Fig. 3 shows, most of the top accounting journals appear to be receptive to investor-related experimental research. Experiments trade off a natural context in order to achieve several other goals. First, experiments have the unique benefit of being able to disentangle the effects of variables that are confounded in a natural setting and isolate and evaluate cause and effect relationships, which reduces the possibility that the inferences drawn from the research are incorrect (Libby, Bloomfield, & Nelson, 2002; McDaniel & Hand, 1996; Schipper, 1994). To achieve these benefits, experimental research trades off external validity. However, as Libby et al. (2002) point out, experimental research that focuses on individual and environmental characteristics improves external validity as it allows identification of how and when results will generalize and how variations in individual or environmental characteristics will change the observed behavior. Second, underlying judgments and mental processes can be measured using experiments, rather than inferred from observable decisions. Third, experiments provide a unique opportunity to understand aspects that either do not exist yet or for which data cannot be collected from the natural setting. In this way, experimental research can add particular value to practice (McDaniel & Hand, 1996) and to the standard-setting process (Schipper, 1994).
Using experimental methods to understand investor perceptions provides many benefits. Investigating perceptions and how these perceptions translate into investment choices contributes to our understanding of how capital markets work and the factors that affect market efficiency. Understanding investor perceptions also provides insight for management decisions. Investors influence management decisions because their perceptions and trading behavior drive the value of executives’ stock compensation. Thus, investor perceptions are one of the many factors that influence management decision-making. In addition, understanding investor perceptions can assist the interested parties external to the firm. Investors can benefit from awareness of biases and heuristics that can affect their objectivity. Standard setters benefit from ex-ante research that can shed light on multiple potential standard-setting options and research that allows standard setters to test out their identified solution to identify any unintended consequences. In this manner, experimental research is more timely and comprehensive than archival research (Libby et al., 2002; McDaniel & Hand, 1996; Schipper, 1994). Experiments also allow comparison of behaviors and outcomes under current conditions with behaviors and outcomes under different conditions, such as in the absence of an intervention or when environmental factors change. The importance of investor perceptions to the many parties described above implies a need to understand investor perceptions more completely.
Within this paper, I take a broad view of investor perception and synthesize the experimental literature that currently exists, ranging from 1983 to 2017, with the purpose of identifying key findings and future research opportunities. Reviews exist for portions of investor experimental research (Han, 2013; Libby et al., 2002; Mercer, 2004) and for investor archival research (e.g., Healy & Palepu, 2001). This comprehensive review extends and complements the existing research syntheses by examining all of the existing experimental research of which I am aware and focusing on the causal effects that can be established with experimental research.1 Through this research synthesis, I group the research into three broad categories that affect investor perceptions: information format, investor features, and disclosure credibility. Each category contains multiple aspects that influence investor perceptions. Fig. 4 broadly depicts the research discussed in this review and highlights that these aspects ultimately influence investor perceptions of confidence, information credibility, firm risk, firm value, and future firm performance.
The remainder of the review is organized as follows. Section 2 discusses information format. Section 3 reviews investor features. Section 4 focuses on disclosure credibility. I conclude in Section 5 with further avenues for future research.2
Section snippets
Information processing
Maines and McDaniel (2000) develop a framework for understanding how information presentation format influences investor judgments. They assert that presentation format influences information processing and investor judgments through affecting the acquisition, evaluation, and/or weighting of the information. Building onto and expanding their framework, existing research examines the effect of information salience, clear labeling, reporting and accounting complexity, financial statement
Using heuristics
It is difficult, if not impossible, to thoroughly analyze the costs and benefits of each option available to investors. Accordingly, investors use heuristics to simplify their decisions. Investments are chosen, in part, based on reasons that make investors have an affective response to the firm, such as the firm appearing on the Fortune “most-admired companies” list (Barber, Heath, & Odean, 2003). Investors will pay more for a firm with positive CSR performance, but the effect disappears when
Disclosure credibility
Managers have some flexibility in what they disclose, especially with respect to future expectations. Given the information asymmetry between managers and investors, investors rely on credibility cues when evaluating disclosed information. Credibility cues can come from characteristics of the disclosure, the degree of external and internal assurance, management’s credibility, and managers’ incentives (Mercer, 2004).
Future research and conclusions
Overall, the research related to investor perceptions and reactions to information highlights that processing firm information is difficult, and there are many aspects to reporting that can help or hinder investors’ efforts to acquire, evaluate, and weight firm information. One benefit of experimental research is the ability to understand whether investors are reacting to the information itself or to some other aspect. As Fig. 1, Fig. 2 illustrate, experimental research related to investors is
Acknowledgements
I would like to thank my dissertation committee members, Markus Brauer, Mark Covaleski, Ella Mae Matsumura (Chair), Brian Mayhew, Alex Stajkovic, and Tyler Thomas for their valuable suggestions and advice. I would also like to express sincere appreciation for the suggestions and advice of Devon Erickson, Steven Kachelmeier, Lisa Koonce, Chad Simon, Brian White, and students at the University of Texas at Austin..
References (140)
- et al.
Do section 404 disclosures affect investors’ perceptions of information systems reliability and stock price predictions?
International Journal of Accounting Information Systems
(2011) - et al.
To blame or not to blame: Analysts’ reactions to external explanations for poor financial performance
Journal of Accounting and Economics
(2005) - et al.
Confidence and the welfare of less-informed investors
Accounting Organizations and Society
(1999) - et al.
To participate or not to participate? Voice and explanation effects on performance in a multi-period budget setting
The British Accounting Review
(2008) - et al.
Investor reactions to management earnings guidance attributions: The effects of news valence, attribution locus, and outcome controllability
Accounting Organizations and Society
(2016) - et al.
The Effect of CEO Reputation and explanations for poor performance on investors’ judgments about the company’s future performance and management
Accounting Organizations and Society
(2010) - et al.
Pro forma accounting disclosures: The effect of reconciliations and financial reporting knowledge on nonprofessional investors’ judgments
Advances in Accounting
(2014) Judging risk and return of financial assets
Organizational Behavior and Human Decision Processes
(2000)- et al.
Fair value accounting for liabilities: The role of disclosures in unraveling the counterintuitive income statement effect from credit risk changes
Accounting Organizations and Society
(2011) - et al.
Experimental tests of the salience theory: Disaggregated income statements under two economic states
Asia-Pacific Journal of Accounting & Economics
(2016)
Are investors really willing to agree to disagree? An experimental investigation of how disagreement and attention to disagreement affect trading behavior
Organizational Behavior and Human Decision Processes
A literature synthesis of experimental studies on management earnings guidance
Journal of Accounting Literature
Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature
Journal of Accounting and Economics
Management reporting incentives and classification credibility: The effects of reporting discretion and reputation
Accounting Organizations and Society
Mandatory management disclosure and mandatory independent audit of internal controls: Evidence of configural information processing by investors
Accounting Organizations and Society
Internet financial reporting: The effects of information presentation format and content differences on investor decision making
Computers in Human Behavior
Fair value accounting for liabilities: Presentation format of credit risk changes and individual information processing
Accounting Organizations and Society
Disclosure readability and the sensitivity of investors’ valuation judgments to outside information
The Accounting Review
Good reasons sell: Reason-based choice among group and individual investors in the stock market
Management Science
Information asymmetry and the ex ante impact of public disclosure quality on price efficiency and the cost of capital: Evidence from a laboratory market
The Accounting Review
Financial accounting research, practice, and financial accountability
Abacus
The neuroscience behind the stock market’s reaction to corporate earnings news
The Accounting Review
Audit fees and investor perceptions of audit characteristics
Behavioral Research in Accounting
A request for more research to support financial accounting standard-setting
Behavioral Research in Accounting
Market reactions to differentially available information in the laboratory
Journal of Accounting Research
Do investors overrely on old elements of the earnings time series?
Contemporary Accounting Research
Feedback loops, fair value accounting and correlated investments
Review of Accounting Studies
Mental accounting and disaggregation based on the sign and relative magnitude of income statement items
The Accounting Review
Does investors’ desire to punish misreporting affect their litigation decisions and managers’ and investors’ welfare?
Behavioral Research in Accounting
A graph is worth a thousand words: How overconfidence and graphical disclosure of numerical information influence financial analysts accuracy on decision making
PLoS One
Effects of governance on investment decisions and perceptions of reporting credibility: Investment experience of Taiwanese individual investors
Asia Pacific Journal of Management
The effects of expected and actual accounting choices on judgments and decisions
The Accounting Review
The effects of presentation salience and measurement subjectivity on nonprofessional investors’ fair value judgments
Contemporary Accounting Research
Can a code of ethics improve manager behavior and investor confidence? An experimental study
The Accounting Review
The impact of nonaudit service fee levels on investors’ perception of auditor independence
Behavioral Research in Accounting
Market efficiency, bounded rationality, and supplemental business reporting disclosures
Journal of Accounting Research
The impact of graphical displays of pro forma earnings information on professional and nonprofessional investors’ earnings judgments
Behavioral Research in Accounting
Are investors influenced by accounting presentation format and announcement prominence of special items?
Independence in appearance and in fact: An experimental investigation
Contemporary Accounting Research
Do investors react differently to range and point management earnings forecasts?
Journal of Behavioral Finance
Are investors influenced by pro forma emphasis and reconciliations in earnings announcements?
The Accounting Review
How disclosure features of corporate social responsibility reports interact with investor numeracy to influence investor judgments
Contemporary Accounting Research
Disaggregating management forecasts to reduce investors’ susceptibility to earnings fixation
The Accounting Review
Earnings metrics, information processing, and price efficiency in laboratory markets
Journal of Accounting Research
The unintended effect of corporate social responsibility performance on investors’ estimates of fundamental value
The Accounting Review
Expected mispricing: The joint influence of accounting transparency and investor base
Journal of Accounting Research
Does concrete language in disclosures increase willingness to invest?
Review of Accounting Studies
Do investors perceive low risk when earnings are smooth relative to the volatility of operating cash flows? Discerning opportunity and incentive to report smooth earnings
The Accounting Review
Unintended consequences of lowering disclosure thresholds
The Accounting Review
Exposure draft: Disclosure of certain loss contingencies: An amendment of FASB statements No. 5 and 141(R)
Cited by (16)
Experimental research on standard-setting issues in financial reporting
2023, Accounting, Organizations and SocietyTalk less and do more: Expected strategic adjustments vs. actual changes in the Chinese firms
2022, Pacific Basin Finance JournalCitation Excerpt :Additionally, corporate information disclosure is usually strategic. Existing literature point out that firm managers manipulate investors' perception of firm value by disclosing the strategic information selectively (Beyer et al., 2010; Lim et al., 2018; Martin, 2019). Second, strategic behavior is usually discussed as the consequence by certain motivation.
Beware the inexperienced financial advisor with a high trait emotional intelligence: Psychological determinants of the misperception of the risk-return relationship
2022, Personality and Individual DifferencesCitation Excerpt :Indeed, experience is an important factor in investors' behavior. According to previous literature, more (vs. less) experienced investors should be better able to understand the market and to judge the future returns independently from their feelings of the moment (Dvorak & Hanley, 2010; Frijns et al., 2014; Martin, 2019). Experienced investors have likely gone through different economic cycles, and they should have learned not to trust their gut feelings too much.
The influence of opportunistic capital structure disclosure in international financial reporting on nonprofessional investors
2021, Journal of International Accounting, Auditing and TaxationCitation Excerpt :Lastly, the experimental method is best suited to examine intervening processes, here recognition of bias in the financial reporting, on investor stock purchasing decisions. Accordingly, to ascertain causal relations between the note disclosures and cautionary guidance on investor judgment and decision-making, an experiment was necessary (Koonce, Seybert, & Smith, 2011; Martin, 2019). The country selected as the context for our study is Canada.
Do ESG progress disclosures influence investment decisions?
2024, International Journal of Disclosure and Governance