Fair Value Measurement Under High Uncertainty: The Effects of Disclosure Format and Management Aggressiveness on Users’ Risk Assessments
55 Pages Posted: 13 Feb 2016
Date Written: January 1, 2015
I examine the extent to which the high degree of inherent risk present in many fair value measurements (FVMs) is communicated via disclosures to financial statement users under conditions of high and low management aggressiveness. Specifically, I conduct an experiment that investigates which of three disclosure formats most effectively communicates the risk of high-uncertainty FVMs to users — a narrative sensitivity disclosure currently mandated in the U.S., a standard quantitative disclosure currently required under IFRS, or an “enhanced” quantitative disclosure I propose that also displays the impact of these changes on net income. As predicted, the enhanced disclosure condition is more effective than the standard condition at communicating risk to users under conditions of high management aggressiveness. Increased perceptions of trust, competence, and reliability upon receiving the standard disclosure partially explain this relationship. Thus, the additional information in the enhanced disclosure condition appears to lead to higher risk assessments when management aggressiveness is high, providing increased benefit to users at little incremental cost to preparers.
Keywords: fair value, estimates, estimation uncertainty, financial statements, disclosure, aggressiveness
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