The Effects of Investors’ Information Processing Limitations When Incorporating Return on Assets into Their Investment Decisions

Abstract

Research suggests that investors fail to fully process changes in return on assets due to their incomplete processing of changes in asset turnover. We propose that investors do not fully process changes in return on assets—stemming from changes in asset turnover—because of their (1) fixation on the income statement, and (2) split attention when integrating summary measures from the income statement and the balance sheet. Using experimental methods, we find that combining relevant financial statement information on a single page improves investors’ processing of return on assets. Further, we find that fully integrating the financial statements by presenting each income statement item as a percentage of average total assets improves investors’ processing of return on assets relative to simply presenting integrated financial statement information in a reconciliation. Our study makes important contributions both to the academic literature and to standard setting by providing an explanation based on investors’ information processing limitations as to why investors do not fully process changes in return on assets. In doing so, we highlight the benefits of presentation formats that fully combine and integrate relevant financial statement information in ameliorating the adverse effects of fixation and split attention.

Keywords: Return on assets, Fixation, Split attention, Presentation format

JEL Classification: M41, D83, C91