How Do Opportunistic Disclosures Impact Nonprofessional Investors’ Decision Making? Disinhibiting and Inhibiting Mechanisms

Abstract

We report the results of an experiment where management discloses in the audited financial statements an opportunistic firm-specific capital structure. This disclosure, required under current IAS 1 rules, is subjective and susceptible to management bias. In our study, if used by nonprofessional investor participants, the disclosed capital structure will lead to higher firm values than would capital structures commonly determined from the firm’s balance sheet. Our results show that the opportunistic capital structure note disclosure influences nonprofessional investors’ judgment and decision making. Indirect effects provide evidence of causal reasons why this occurs. When provided the note disclosure, nonprofessional investors value the firm greater and believe it is a more attractive investment which function as disinhibiting mechanisms underlying stock purchasing decisions. In contrast, nonprofessional investors’ ability to recognize bias in the firm’s financial reporting operates as an inhibiting mechanism underlying stock purchasing decisions. We also find cautioning participants of management’s ability to distort the disclosure had no effect, differing from prior research. Our study adds to the disclosure literature and has important implications for investors, standard setters, and auditors as it raises questions of how to protect society from permitted opportunistic accounting disclosures.

Keywords: accounting standards, disclosures, investor, caution, anchor

JEL Classification: M41