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Abstract:
This paper examines the judgmental effects of the balanced scorecard. The balanced scorecard contains a large number of financial and nonfinancial performance measures divided into four categories. Based on judgment and decision making theory we examine whether the organization of the information and the diverse (common and unique) measures contained in the scorecard result in differences in managerial performance evaluation judgments. We find that relative performance evaluations are affected by organizing the measures into the balanced scorecard categories. Further, when scorecards for two divisions contain some common and some unique measures, performance evaluations are affected only by the common measures.

Abstract:
Although information that firms provide about financial instruments and derivatives should help investors judge risk, such information often is not effective for this purpose. We experimentally demonstrate that the labels firms use to describe financial instruments and derivatives cause investors to judge risk based on thoughts associated with the labels rather than the underlying economic exposures of those instruments. We also show that loss-only disclosures currently used to describe the market risks facing companies force investors to make assumptions or inferences to judge risk. These inferences are systematic and often incorrect. We test two possible disclosures that might remedy these problems. Our results show that labeling effects are not eliminated by additional disclosures explicating the underlying economic exposures, but that providing investors with upside and downside market-risk disclosures help them distinguish among firms using different risk management strategies. Implications for managers and regulators are provided.

Financial instruments and derivatives, risk judgments, investor behavior

Abstract:
How do investors evaluate managers who choose to use or not use derivatives once the outcomes of those decisions become known? Competing theories make different predictions, and we test these in three experiments. Results show that even when outcomes are held constant, investors are more satisfied and assign a higher value to a company that uses derivatives than to one that does not use derivatives. This finding is consistent with decision justification theory. Additional tests reveal that this result occurs because investors believe that firm managers who use derivatives to address risk exposures exhibit a higher level of decision-making care. In contrast, we find that speculative use of derivatives is not assumed to result from careful thought, resulting in harsher judgments about management. Overall, our study adds to our understanding of how investors judge companies who use derivatives, given the outcomes that result from such use.

Derivatives, valuation, judgment and decision making

Abstract:
Archival research shows that the market reacts to earnings trend as well as to earnings performance relative to analysts’ forecasts (i.e., benchmark performance). We conduct four experiments to investigate how and why investors react to these two measures when both are available over multiple time periods. Our results show that investors generally rely only on a performance measure when it is consistent over time, although we find some use of benchmark information (i.e., meet/beat performance) even when it is inconsistent. When both earnings trend and benchmark performance are consistent over time, investors use both in an additive fashion, suggesting that they view them as providing different information about the firm. Further tests suggest investors believe that earnings trend provides information about a firm’s future prospects, while benchmark performance offers information about the firm’s future prospects and management’s credibility. Our study has implications for firm managers and researchers.

Earnings benchmarks, earnings trends, investor reaction, consistency across time