Elsevier

Journal of Accounting Literature

Volume 43, December 2019, Pages 145-169
Journal of Accounting Literature

Examination and implications of experimental research on investor perceptions

https://doi.org/10.1016/j.acclit.2019.11.001Get rights and content

Abstract

This paper synthesizes existing experimental research in the area of investor perceptions and offers directions for future research. Investor-related experimental research has grown substantially, especially in the last decade, as it has made valuable contributions in establishing causal links, examining underlying process measures, and examining areas with little available data. Within this review, I examine 121 papers and identify three broad categories that affect investor perceptions: information format, investor features, and disclosure credibility. Information format describes how investors are influenced by information salience, information labeling, reporting and accounting complexity, financial statement recognition, explanatory disclosures, and proposed disclosure changes. Investor features describes investors’ use of heuristics, investor preferences, and the effect of investor experience. Disclosure credibility is influenced by external and internal assurance, management credibility, disclosure characteristics, and management incentives. Using this framework, I summarize the existing research and identify areas that would benefit from additional research.

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..

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