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Estimate-related disclosures, investor mindset, and the illusion of precision in financial statement estimates

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Title: Estimate-related disclosures, investor mindset, and the illusion of precision in financial statement estimates
Author(s): White, Brian
Director of Research: Elliott, Wynter B.
Doctoral Committee Chair(s): Elliott, Wynter B.
Doctoral Committee Member(s): Peecher, Mark E.; Hobson, Jessen L.; Wyer, Robert S., Jr.
Department / Program: Accountancy
Discipline: Accountancy
Degree Granting Institution: University of Illinois at Urbana-Champaign
Degree: Ph.D.
Genre: Dissertation
Subject(s): investor mindset investment horizon fair value required disclosures
Abstract: This study examines the joint effect of disclosed measurement information and investor mindset associated with differences in temporal orientation on investors' judgments of estimate precision and firm value. Consistent with psychology theory, results reveal that short horizon investors adopt a relatively concrete mindset and long horizon investors adopt a relatively abstract mindset. As a consequence, disclosing that the recognized fair value of an impaired asset was derived from unobservable (i.e., level 3) inputs strongly influences short horizon investors’ judgments of estimate precision. By contrast, disclosing this information has a significantly smaller impact on the precision judgments of long horizon investors. Additional analyses reveal that, in the absence of disclosure, investors attribute a relatively high default level of precision to a recognized estimate, suggesting that concerns about an illusion of precision may be justified. Further evidence indicates that mindset and disclosed measurement information jointly influence investors’ valuation judgments in a way that is inconsistent with statistical decision theory and standard models of firm value. Specifically, long horizon investors’ valuation judgments reflect the negative effect of an asset impairment with no significant effect of differences in measurement. By contrast, short horizon investors’ concrete mindsets lead them to interpret higher (lower) estimate precision as a positive (negative) signal about firm value in its own right. Thus, rather than placing greater weight on a more precisely measured estimate, short horizon investors’ fixation on measurement causes them to disregard the negative effect of the asset impairment on firm value when it is measured relatively precisely, but amplify the negative effect in response to imprecise measurement. A supplemental experiment uses an alternative manipulation of investors’ temporal orientation to instantiate mindset, and tests the incremental impact of providing detailed quantitative disclosures for recognized fair values that are derived from unobservable inputs, as required by a recent update to US and international accounting standards. Results reveal that providing these additional disclosures strongly reduces the precision judgments of investors with a short-term orientation, but does not significantly affect the precision judgments of investors with a long-term orientation. The theory and results presented here may be useful in judging the effectiveness of existing and proposed disclosures in communicating information about estimate precision. Further, this study makes a unique contribution to the accounting literature by providing theory and empirical evidence that investor mindset varies systematically with investment horizon, and influences investors’ evaluation and use of accounting information in ways that are likely unanticipated by regulators and standard setters relying on standard economic theory.
Issue Date: 2012-06-27
URI: http://hdl.handle.net/2142/32003
Rights Information: Copyright 2012 Brian White
Date Available in IDEALS: 2012-06-27
Date Deposited: 2012-05
 

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