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Abstract:
We gather data from 77 current mid-level managers and 111 future entry-level managers, to investigate how they value stock options and restricted stock. We refer to our current and future manager groups collectively as "managers." We supplement our manager data with a dozen field interviews with senior executives. We find that managers, on average, systematically overvalue stock options relative to both the Black-Scholes (B-S) value and fair-value equivalent restricted stock grants. Thus, contrary to conventional economic thinking, many risk-averse agents do not appear to discount B-S values of options. Further, in valuing options, managers value quick vesting and extended expiration. Managers also extrapolate recently rising stock price trends to arrive at their subjective valuations of both options and restricted stock. In general, our results suggest that a combination of economic, behavioral and demographic factors explain managers' subjective valuations of options and restricted stock.

stock options, restricted stock, managers

Abstract:
In this study we report the results of an experiment that examines how relatively sophisticated financial statement users interpret management stock option compensation disclosures under SFAS No. 123 and SFAS No. 123R. We predict and find that mandated income statement recognition, as required under SFAS No. 123R, leads to higher user assessments of reliability than either voluntary income statement recognition or voluntary footnote disclosure, options allowed under SFAS No. 123. Users view voluntary footnote disclosure as the least reliable reporting alternative. We also examine the amount users invest in response to these accounting treatments, and find that users invest more in a firm when management chooses income statement recognition than when management chooses footnote disclosure. We find no difference in investment amounts between mandated recognition and either voluntary recognition or footnote disclosure. Finally, although we find that these results are insensitive to whether management explicitly disavows the reliability of stock option expense, we present evidence that in side-by-side comparisons, where one firm disavows and the other does not, disavowals may affect user judgments and decisions.

Disavowal, mandated disclosures, stock options, voluntary disclosures, experience

Abstract:
In this study we report the results of an experiment that examines how relatively sophisticated financial statement users interpret management stock option compensation disclosures under SFAS No. 123 and SFAS No. 123R. We predict and find that mandated income statement recognition, as required under SFAS No. 123R, leads to higher user assessments of reliability than either voluntary income statement recognition or voluntary footnote disclosure, options allowed under SFAS No. 123. Users view voluntary footnote disclosure as the least reliable reporting alternative. We also examine the amount users invest in response to these accounting treatments, and find that users invest more in a firm when management chooses income statement recognition than when management chooses footnote disclosure. We find no difference in investment amounts between mandated recognition and either voluntary recognition or footnote disclosure. Finally, although we find that these results are insensitive to whether management explicitly disavows the reliability of stock option expense, we present evidence that in side-by-side comparisons, where one firm disavows and the other does not, disavowals may affect user judgments and decisions.

Disavowal, mandated disclosures, stock options, voluntary disclosures, experience

Abstract:
In this study we report the results of a laboratory experiment in which we examine whether the credibility of management's balance-sheet classification of hybrid securities as liabilities or equity is a joint function of (1) the level of classification discretion in the reporting environment, (2) whether management's classification choice is consistent or inconsistent with reporting incentives, and (3) management's reporting reputation. Our results suggest that when classification is mandated, credibility is unrelated to management's reporting reputation and whether management's classification choice is consistent or inconsistent with incentives. When classification is discretionary, financial report users consider management's classification choice more credible when it is inconsistent with incentives. Users are sensitive to management's reporting reputation only when classification is discretionary and management's classification choice is consistent with incentives. We also find that the association between the credibility of management's classification choice and user assessments of financial performance depends upon whether the classification is consistent or inconsistent with incentives. Finally, our results suggest that a good reporting reputation leads to higher financial performance assessments in both mandated and discretionary reporting environments. Implications, limitations, and future research are also discussed.

credibility, financial reporting reputation, discretionary disclousre, hybrid securities, financial statement analysis

Abstract:
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), in their joint Financial Statement Presentation project, are reconsidering the basic format of financial statements. The Boards' preliminary discussions related to this joint project indicate that they intend to modify the required financial statements to increase the proximity of performance-related information for each reported period, but also to reduce the number of reported periods. We provide evidence related to each of these potential changes by investigating the effects of financial-statement information proximity and the number of periods of reported performance on investors' ability to learn the forecast-relevant time-series properties of reported cash flows and accruals. Our experimental results suggest that nonprofessional investors are able to more quickly learn the relation between current period cash flows and accruals and future cash flow realizations when financial-statement information is presented in a single statement rather than separated into two statements. In addition, we find that nonprofessional investors exhibit lower levels of absolute forecast errors and less forecast dispersion when financial-statement information is unified into a single statement. Interestingly, we find that decreasing the number of periods of reported information from three to one does not negatively impact nonprofessional investor learning and prediction performance, both in terms of forecast errors and forecast dispersion. Overall, our results provide useful information related to the design of effective financial statement presentation format.

proximity, feedback, financial statement format, cash flows, forecasting, judgment and decision making

Abstract:
In this study we conduct a field experiment to examine how qualifying an income-decreasing accounting change in years of strong financial performance affects user assessments of strategic reporting, current financial performance, and financial performance over the next three years (future performance). We find that without the qualification, users viewed the income-decreasing accounting change as relatively non-strategic, and user assessments of current and future performance were not different. In the presence of the qualification, users believed that the accounting change was relatively strategic, they discounted the income effect of the accounting change, and their assessments of future performance were below their assessments of current performance but no different from the assessments of future performance in the absence of the qualification. While our findings suggest audit qualifications encourage users to be skeptical of income-decreasing accounting changes, we find no evidence that they impose negative consequences on management in terms of lower assessments of financial performance.

Income-decreasing accounting changes, Audit report, Financial performance, Strategic financial reporting

Abstract:
In this study we conduct a field experiment to examine how qualifying an income-decreasing accounting change in years of strong financial performance affects user assessments of strategic reporting, current financial performance, and financial performance over the next three years (future performance). We find that without the qualification, users viewed the income-decreasing accounting change as relatively non-strategic, and user assessments of current and future performance were not different. In the presence of the qualification, users believed that the accounting change was relatively strategic, they discounted the income effect of the accounting change, and their assessments of future performance were below their assessments of current performance but no different from the assessments of future performance in the absence of the qualification. While our findings suggest audit qualifications encourage users to be skeptical of income-decreasing accounting changes, we find no evidence that they impose negative consequences on management in terms of lower assessments of financial performance.

Income-decreasing accounting changes, audit reports, financial performance, strategic financial reporting

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a reasonable proxy for nonprofessional investors. We investigate this assumption using two settings: (a) an experimental setting from a recent paper that relies on this assumption, and (b) by using a proprietary dataset from a publicly traded company's investor relations website. Our analysis reveals that, on average, early MBA students (i.e., students beginning the "core" MBA classes) acquire information as well as nonprofessional investors but that they are unable to integrate that information with other information when making investment-related judgments and decisions. In contrast, select MBA students (i.e., students who have completed the core and elected to take a financial analysis course) acquire and integrate information as well as nonprofessional investors when making investment-related judgments and decisions. Further tests reveal that early MBA students with significant work experience (e.g., greater than five years) perform better than less experienced, early MBA students and not significantly different from nonprofessional investors. Our results suggest that using graduate business students as a proxy for nonprofessional investors is a valid methodological choice, provided researchers give careful consideration to aligning their tasks with the appropriate level of education and/or work experience.

Investor sophistication, behavioral research in accounting, stock options

Abstract:
In this paper we use a unique dataset to investigate the relationship between nonprofessional investors' information choices and their portfolio returns. We also investigate the role investing experience plays in this relationship. We find that nonprofessional investors earn lower returns as their use of unfiltered information (e.g., SEC filings) increases relative to their use of filtered information (e.g., Value Line analysts reports), and that investment experience not only moderates but actually reverses this negative relationship. Specifically, less (more) experienced nonprofessional investors earn lower (higher) returns as their use of unfiltered information increases. Our results suggest that this effect is driven by investors' ability to understand and use unfiltered information as they gain investing experience, not by a shift in their information choices. These findings are particularly relevant in the current reporting environment where greater numbers of inexperienced investors are entering the markets and recent legislation (e.g., Sarbanes Oxley Act of 2002) requires firms to disclose more detailed financial information.

Nonprofessional Investors, Information Choice, Unfiltered Information

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a good proxy for non-professional investors. To conduct our investigation, we categorize recent experimental studies in financial accounting based on the relative level of integrative complexity inherent in each study's task. We then conduct experiments using two tasks, one that is relatively low in integrative complexity and one that is relatively high in integrative complexity, and compare the responses of two groups of MBA students and non-professional investors.

Our results suggest that using MBA students as a proxy for non-professional investors is a valid methodological choice, provided researchers give careful consideration to aligning a task's integrative complexity with the appropriate level of MBA student. MBA students who have completed their core MBA courses and are enrolled in or have completed a financial statement analysis course are a good proxy for non-professional investors in tasks that are relatively low in integrative complexity. Though less definitive, the majority of our tests also suggest that these students are a good proxy for non-professional investors in tasks that are relatively high in integrative complexity. However, care must be taken when using students in the first-year core financial accounting course. In tasks that are relatively low in integrative complexity, these students perform similarly to non-professional investors except when they are asked to make an investment decision. In tasks that are relatively high in integrative complexity, these students acquire information similarly to non-professional investors, but they do not appear to integrate the information in a similar manner.

sophistication, behavioral research in accounting, stock options

Abstract:
Restatements are economically significant events that damage investor trust in a firm’s financial reporting. We conduct an experiment to investigate how using online video to announce a restatement interacts with the level of responsibility a manager assumes for the restatement to influence investors’ perceptions of management’s trustworthiness and post-restatement investment decisions. We examine the use of online video for restatement disclosure due to video’s recent, explosive growth as a corporate communication tool. Our results reveal that when the CEO’s firm is the only firm restating, participants viewing the restatement announcement online via video make larger investments in the firm and are more confident in the firm’s future ability to meet analysts’ expectations than are participants who view the restatement announcement online via text. However, we do not observe this effect when the CEO’s firm and its industry peers are restating. Our results also reveal that participants’ perceptions of management’s trustworthiness mediate the influences of disclosure venue and assumed responsibility on post-restatement investment decisions. These findings are important given the dramatic increase in the number of restatements over time, the resultant deterioration of investor trust, and the Security and Exchange Commission’s recent emphasis on transitioning from traditional, paper-based to new, Internet-based disclosure venues.

trust, investor, investment decision, responsibility, disclosure venue, online video

Abstract:
We conduct a field survey to investigate whether current mid-level and future entry-level managers (collectively managers) subjectively value stock options and restricted stock consistent with economic theory. We find that managers, on average, subjectively value stock options at greater than their Black-Scholes value and greater than fair-value equivalent restricted stock. This result contrasts with conventional economic wisdom that risk-averse employees discount the Black-Scholes value of an option. With respect to stock options, our results also reveal that managers, on average, have a lottery ticket mentality when subjectively valuing options, they value shorter vesting periods, and they value longer terms to maturity. With respect to stock options and restricted stock, we find that managers tend to extrapolate recently rising stock price trends to arrive at their subjective values. Overall, our results suggest that in some cases standard economic theory does not accurately reflect how managers appear to subjectively value stock options and restricted stock.

Stock options, Restricted stock, Managers' subjective values, Black-Scholes model

Abstract:
In this paper we investigate the relationship between non-professional investors' information choices and their portfolio returns. We also investigate the role investing experience plays in this relationship. We find that non-professional investors earn lower returns as their use of unfiltered information (e.g., SEC filings) increases relative to their use of filtered information (e.g., Value Line analyst reports). We also find that investing experience mitigates this negative relationship. The latter result appears to be driven by investors' use of unfiltered (as opposed to filtered) information as they gain investing experience.

Abstract:
In this study we use a unique dataset to examine whether professional and nonprofessional investors use different online quarterly financial information when making investment decisions, and whether the online information they use depends on whether they are researching a new investment or evaluating a current investment. Our results suggest professional investors prefer to view PDF-formatted quarterly reports and tend to rely directly on the financial statements compared to nonprofessional investors who prefer to view HTML-formatted reports and have a tendency to rely more on management's discussion of the quarter's results. Our results also suggest that for nonprofessional investors, investment familiarity (i.e., whether they are evaluating a current investment or researching a new investment) strongly impacts the type of financial information they view within a firm's quarterly reports. Our results have implications for the design of experimental studies, and provide information useful to managers, financial report users, standard setters, and researchers as they attempt to better understand the types of information that professional and nonprofessional investors use when making investment decisions.

Expertise, investment familiarity, online reporting, experimental design

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a good proxy for non-professional investors. To conduct our investigation, we categorize recent experimental studies in financial accounting based on the relative level of integrative complexity inherent in each study's task. We then conduct experiments using two tasks, one that is relatively low in integrative complexity and one that is relatively high in integrative complexity, and compare the responses of two groups of MBA students and non-professional investors.

Our results suggest that using MBA students as a proxy for non-professional investors is a valid methodological choice, provided researchers give careful consideration to aligning a task's integrative complexity with the appropriate level of MBA student. MBA students who have completed their core MBA courses and are enrolled in or have completed a financial statement analysis course are a good proxy for non-professional investors in tasks that are relatively low in integrative complexity. Though less definitive, the majority of our tests also suggest that these students are a good proxy for non-professional investors in tasks that are relatively high in integrative complexity. However, care must be taken when using students in the first-year core financial accounting course. In tasks that are relatively low in integrative complexity, these students perform similarly to non-professional investors except when they are asked to make an investment decision. In tasks that are relatively high in integrative complexity, these students acquire information similarly to non-professional investors, but they do not appear to integrate the information in a similar manner.

sophistication, behavioral research in accounting, stock options

Abstract:
XBRL (Extensible Business Reporting Language) is an emerging technology that facilitates directed searches and simultaneous presentation of related financial statement and footnote information. We investigate whether using an XBRL-enhanced search engine helps nonprofessional financial statement users acquire and integrate related financial information when making an investment decision. We conduct our investigation in the context of recognition versus disclosure of stock option compensation. Our results reveal that many users do not access the technology, but those that do use it are better able to acquire and integrate information. Specifically, we find that when stock option accounting varies between firms, the use of an XBRL-enhanced search engine increases the likelihood that individuals acquire information about stock option compensation disclosed in the footnotes. We also find that XBRL helps individuals integrate the implications of this information, resulting in different investment decisions between individuals who use and do not use the search engine. Our results suggest that search-facilitating technologies, such as XBRL, aid financial statement users by improving the transparency of firms' financial statement information and managers' choices for reporting that information. Our results also reveal that wide publicity about the benefits of using search-facilitating technology may be needed to induce financial statement users to access the technology.

Abstract:
XBRL (Extensible Business Reporting Language) is an emerging technology that facilitates directed searches and simultaneous presentation of related financial statement and footnote information. We investigate whether using an XBRL-enhanced search engine helps nonprofessional financial statement users acquire and integrate related financial information when making an investment decision. We conduct our investigation in the context of recognition versus disclosure of stock option compensation. Our results reveal that many users do not access the technology, but those that do use it are better able to acquire and integrate information. Specifically, we find that when stock option accounting varies between firms, the use of an XBRL-enhanced search engine increases the likelihood that individuals acquire information about stock option compensation disclosed in the footnotes. We also find that XBRL helps individuals integrate the implications of this information, resulting in different investment decisions between individuals who use and do not use the search engine. Our results suggest that search-facilitating technologies, such as XBRL, aid financial statement users by improving the transparency of firms' financial statement information and managers' choices for reporting that information. Our results also reveal that wide publicity about the benefits of using search-facilitating technology may be needed to induce financial statement users to access the technology.

recognition, disclosure, transparency, XBRL

Abstract:
Research suggests that investors and creditors react less strongly to information disclosed in footnotes than to information recognized on the face of financial statements, due at least in part to cognitive processing limitations. Emerging technologies (e.g., XBRL) that facilitate directed searches and simultaneous presentation of related financial statement and footnote information could potentially alleviate these limitations. We use an experiment to investigate whether the use of a search-facilitating technology affects how individuals react to recognition versus disclosure of stock option compensation. We find that the use of search-facilitating technology reduces differences in nonprofessional investors' financial performance judgments and investment decisions created by recognition versus disclosure. Additionally, we provide evidence that investors perceive greater differences in financial statement reliability between recognition and disclosure when they use search-facilitating technology. Overall, our findings suggest that search-facilitating technology improves the transparency of financial statement information and therefore may reduce incentives for firms to lobby for or to choose footnote disclosure to minimize the effects of negative information.

recognition, disclosure, transparency, XBRL

Abstract:
In this study we examine how an audit qualification of an accounting change affects investor assessments of the firm's current and future financial performance, and the representational faithfulness of the change. We investigate this issue for income-increasing and income-decreasing accounting changes, and across four apparent reporting strategies: reporting aggressively, taking a bath, creating hidden reserves, and employing no apparent strategy. Our results show that the effect of the qualification on assessments of current and future performance depends on whether the accounting change increases or decreases reported net income. When an income-increasing accounting change is qualified, investors decrease their assessments of current and future financial performance; when an income-decreasing accounting change is qualified, investor assessments of financial performance are either unaffected or decreased depending on the apparent reporting strategy. We also find evidence that assessments of representational faithfulness relate positively (negatively) to assessments of financial performance when accounting changes are income increasing (decreasing), and under all conditions qualifications reduce investor assessments of representational faithfulness. Avenues for future research are also discussed.

accounting changes, audit reports, financial performance, representational faithfulness

Abstract:
This study provides evidence that hyperlinking a firm's audited financial statements to unaudited information in a Web-based environment leads investors to blend the unaudited information with the audited statements. I obtain evidence of this blending effect using an experiment where investors assessed a firm's earnings potential by evaluating the firm's audited financial statements and a subsequent optimistic unaudited letter to shareholders from the firm's management. Investors who viewed hyperlinked materials on the Web misclassified more unaudited information as audited, and assessed the credibility of the unaudited information as higher, than did investors who viewed hardcopy materials. Those investors who assessed the unaudited information as more credible also judged the firm's earnings potential to be higher. Notifying users with an "AUDITED/NOT AUDITED" label attenuated these effects. This evidence suggests that firms can influence financial report users' perceptions by hyperlinking unaudited information to information in their audited financial statements, and that a simple disclosure rule reduces this influence.

World Wide Web; Financial statement analysis; Audited/unaudited; Presentation format

Abstract:
This paper provides evidence that hyperlinking a firm's audited financial statements to unaudited information in a Web-based environment facilitates a blending of the unaudited information into the audited report. I obtain evidence of this blending effect using an experiment where investors assessed the earnings potential of a firm by evaluating the firm's audited financial statements and a subsequent optimistic unaudited letter to shareholders from the firm's management. Results show that investors who viewed hyperlinked materials on the Web misclassified more unaudited information as audited, and assessed the credibility of the unaudited information as higher, than did investors who viewed hardcopy materials. Those investors who assessed the unaudited information as more credible also judged the firm's earnings potential to be higher. Notifying users with an "AUDITED/NOT AUDITED" label attenuated these effects. This evidence suggests that firms can influence financial report users' perceptions by hyperlinking unaudited information to information in their audited financial statements, and that a simple disclosure rule reduces this influence.

World Wide Web; Financial statement analysis; Audited/unaudited; Presentation format