The effect of a warning on investors’ reactions to disclosure readability

• Published in: Review of accounting studies 2023-06, Vol.28 (2), p.769-791
• Main Authors: Koonce, Lisa, Leitter, Zheng, White, Brian
• Format: Article
• Language: English
• Subjects: Accounting/Auditing; Business and Management; Corporate Finance; Disclosure; Financial statements; Public Finance; Readability
• ISSN: 1380-6653; 1573-7136
• DOI: 10.1007/s11142-021-09655-z

Managers may strategically use discretion over disclosure language to reduce the effect of bad news, amplify the effect of good news, or both. We experimentally test how a warning highlighting management’s discretion over disclosure language affects investors’ reactions to more and less readable disclosures. We find that the warning works as intended for good news disclosures, causing investors to reduce their valuations of the firm when readability choices match management incentives. In the case of bad news disclosures, however, investors do not react as intended to the warning. Additional experiments yield two key findings. (1) The warning works for good news disclosures because of its reference to the way disclosure content could be communicated and not because of its reference to the disclosure content itself. (2) The warning does not work as intended for bad news disclosures because investors do not believe that management strategically uses readability in this situation. Our results should inform regulators, given their interest in both promoting more readable disclosures and protecting investors.