Description
Security laws and accounting standards suggest that reasonable investors' expectations are an important
consideration for disclosure judgments. Regulators have expressed concerns that many disclosure
judgments are made without adequate consideration of how investors would evaluate the information.
However, the psychological literature suggests that individuals may face difficulties considering the facts
from another's perspective. We conduct two experiments to examine whether prompting managers to
take the perspective of a reasonable investor affects their disclosure recommendations of a probable
negative change in their company's earnings expectations, and whether this effect is impacted by the
firm's prior disclosure policy (known that its past preference to be biased towards no disclosure versus
unknown). We find that experienced managers are more likely to recommend disclosure when they are
prompted to take the perspective of a reasonable investor than when they are not and this effect is
stronger when the firm's prior disclosure policy is unknown.
The effects of a reasonable investor perspective and ?rm's prior
disclosure policy on managers' disclosure judgments
*
Diane Mayorga
*
, Ken T. Trotman
**
School of Accounting, UNSW Australia, Australia
a r t i c l e i n f o
Article history:
Received 25 June 2013
Received in revised form
16 October 2015
Accepted 17 October 2015
Available online xxx
Keywords:
Disclosure policy
Perspective taking
Reasonable investor
Reasonable person
a b s t r a c t
Security laws and accounting standards suggest that reasonable investors' expectations are an important
consideration for disclosure judgments. Regulators have expressed concerns that many disclosure
judgments are made without adequate consideration of how investors would evaluate the information.
However, the psychological literature suggests that individuals may face dif?culties considering the facts
from another's perspective. We conduct two experiments to examine whether prompting managers to
take the perspective of a reasonable investor affects their disclosure recommendations of a probable
negative change in their company's earnings expectations, and whether this effect is impacted by the
?rm's prior disclosure policy (known that its past preference to be biased towards no disclosure versus
unknown). We ?nd that experienced managers are more likely to recommend disclosure when they are
prompted to take the perspective of a reasonable investor than when they are not and this effect is
stronger when the ?rm's prior disclosure policy is unknown.
© 2015 Elsevier Ltd. All rights reserved.
1. Introduction
Securities laws and accounting standards around the world
suggest that managers consider the perspective of a ‘reasonable
investor’ when they evaluate whether their listed company has an
obligation to inform the investing public of events and circum-
stances that could materially affect the price of their ?rm's
securities. In fact, the words ‘reasonable person’ and ‘reasonable
investor’ are pervasive in the legislation of many countries
including Australia, UK and USA. However, regulators are
concerned that managers are making many disclosure judgments
without fully considering the disclosure matter from a benchmark
of how a reasonable investor would evaluate the information
(Pozen, 2008, p. 80). Research also indicates that managers'
disclosure judgments are affected by their ?rm's preferences and
experiences for the way disclosure is managed (hereafter referred
to as the ‘?rm's prior disclosure policy’) (e.g., Bamber, Jiang, &
Wang, 2010; Gibbins, Richardson, & Waterhouse, 1990; Holland,
2005).
Given the requirement to consider the viewpoint of a reasonable
investor when making disclosure decisions, our study investigates
whether managers are more likely to recommend disclosure of a
probable negative change in their company's earnings expectations
when they are prompted to take the perspective of a reasonable
investor and whether this effect is increased or decreased when
managers know the ?rm's prior disclosure policy has been biased
towards no disclosure. Our study examines the research questions
in the context of Australia's Continuous Disclosure (‘CD’) environ-
ment although it is noted that CD obligations are also relevant to
many other countries including Canada, Hong Kong, New Zealand,
Singapore and the UK. Australia's CD regulation requires that
companies promptly disclose information that a reasonable person
would expect to have a material effect on the price or value of their
securities unless certain exceptions are satis?ed including that a
*
We thank Robert Bloom?eld (editor), two anonymous reviewers, Hun-Tong Tan,
and workshop participants at UNSW Australia for their helpful suggestions and
comments. We also thank the managers who participated in our study. The ?rst
author gratefully acknowledges the helpful comments from her dissertation ex-
aminers and the ?nancial assistance of the AFAANZ/CPA/Australia/ICAA/NIA PhD
Scholarship.
* Corresponding author. School of Accounting, UNSW Business School, UNSW
Australia, Sydney, NSW 2052, Australia.
** Corresponding author. School of Accounting and Centre for Accounting and
Assurance Research, UNSW Business School, UNSW Australia, Sydney, NSW 2052,
Australia.
E-mail addresses: [email protected] (D. Mayorga), [email protected].
au (K.T. Trotman).
Contents lists available at ScienceDirect
Accounting, Organizations and Society
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0361-3682/© 2015 Elsevier Ltd. All rights reserved.
Accounting, Organizations and Society xxx (2015) 1e13
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
reasonable person would not expect the information to be dis-
closed.
1
Despite the importance of the reasonable investor concept,
little empirical evidence exists regarding its effect on the judg-
ments of preparers, audit committees or auditors (for an exception
see Altiero, Kang, & Peecher, 2015 who examine perspective taking
on auditor judgments).
Research in psychology shows that while individuals have the
ability to take another person's perspective into account (Davis, 1983;
Epley, 2008; Epley & Caruso, 2009; Keysar & Barr, 2002), they may
face dif?culties in getting beyond their ownpoint of viewto consider
the facts fromanother's perspective (e.g., Epley&Caruso, 2009; Epley,
Keysar, Boven, &Gilovich, 2004). Additionally, psychological research
on the impact of motivated reasoning suggests that individuals face
dif?culties in evaluating information and making judgments impar-
tially when they have a stake in reaching a particular outcome
(Kunda, 1990). For instance, individuals judge evidence supporting
their preferred outcomes to be more important and to have stronger
implications than evidence con?icting with their preferred outcome
(e.g., Ditto & Lopez, 1992; Lord, Ross, & Lepper, 1979). Accounting
research ?nds that, given suf?cient ambiguity, accounting pro-
fessionals' judgments are vulnerable to motivated reasoning effects
(Hackenbrack & Nelson, 1996; Kadous, Kennedy, & Peecher, 2003;
Peecher, Piercey, Rich, & Tubbs, 2010) and that pre-existing prefer-
ences to reach a certain desired outcome indirectly in?uence pro-
fessionals' judgments byaffectingthemanner inwhichinformationis
evaluated (e.g., Wilks, 2002). As managers have clear preferences
regarding their ?nancial reporting choices (Bamber et al., 2010), we
contend that when managers do not consider a reasonable investor's
perspective they may take advantage of the uncertainty surrounding
a disclosure issue to arrive at a self-interested disclosure recom-
mendation as long as their disclosure outputs are justi?able.
Our paper reports the results of two experiments. In the ?rst
experiment, we manipulate whether managers are prompted to
consider the perspective of a reasonable investor (prompt versus no
prompt) and knowledge of the ?rm's prior disclosure policy
(known, that its past preference is biased towards no disclosure,
versus unknown) to examine the impact on disclosure judgments
for a new subjective disclosure matter. Experienced senior ?nance
managers, mainly company secretaries,
2
make a disclosure
recommendation on whether a probable negative change in the
company's earnings expectations should be disclosed. Our results
show that managers make disclosure recommendations that are
more supportive of disclosing a negative change in earnings' ex-
pectations when they are prompted to take a reasonable investor's
perspective compared to when they are not and this effect is
stronger when managers do not know the ?rm's prior disclosure
policy.
We conduct a second experiment to establish that our results
are robust to the way managers are prompted to consider the
perspective of a reasonable investor when making disclosure rec-
ommendations. We design the experiment to include an indirect
approach to stimulate managers' consideration of a reasonable
investor's perspective. This approach allows us to examine the ef-
fect of a reasonable investor prompt on managers' disclosure rec-
ommendations while reducing possible demand effects. In a 1 x 3
experiment, we replicate the reasonable investor prompt manip-
ulation used in the ?rst experiment (i.e., managers are prompted to
take the perspective of a reasonable investor or not) as well as add a
new prompt condition in which managers rate the likelihood that
the disclosure matter would in?uence a reasonable investor's in-
vestment decision prior to making their own disclosure recom-
mendation. We ?nd that managers in both prompt conditions are
more likely to recommend disclosure of a probable negative change
in their company's earnings expectations than managers in the no
prompt condition. Our additional analysis shows that managers
who are prompted to take the perspective of a reasonable investor
are more likely to consider reasons for and against disclosing a
probable negative change in their company's earnings expecta-
tions. This suggests that perspective taking may be an effective
mechanism to reduce unintentional biases in interpreting and
evaluating information.
2. Background and hypothesis development
2.1. Reasonable person concept and Australia's continuous
disclosure regime
‘Reasonable person’ is a legal construct. The term originates
from the English legal system enabling issues of ‘ought’ to be
resolved by reference to the objective fact of whether a reasonable
person would have done likewise (Uren, 2003). In law, ‘reasonable
person’, as a reference to a community standard, has been a
powerful metaphor for establishing negligence.
3
The concept of a
reasonable person has also been a signi?cant feature in the pro-
fessional accounting literature for many decades. For example, in
its Statement of Financial Accounting Concepts No. 2, the Finan-
cial Accounting Standards Board's states that “the omission or
misstatement of an item in a ?nancial report is material if, in the
light of surrounding circumstances, the magnitude of the item is
such that it is probable that the judgment of a reasonable person
relying upon the report would have been changed or in?uenced
by the inclusion or correction of the item” (FASB, 1980). The SEC
provides guidance that a matter is material “if there is a sub-
stantial likelihood that a reasonable person would consider it
important” (SEC, 1999). This formulation is reinforced by legal
decisions, such as that rendered by the US Supreme Court which
held that “an omitted fact is material if there is a substantial
likelihood that a reasonable shareholder would consider it
important in deciding how to vote”.
4
In more recent auditing and
accounting settings, the reasonable person/reasonable investor
standard has been applied in determining auditor independence
(AICPA, 1988; APESB, 2007), in the consideration of materiality in
planning and performing audits (IFAC, 2006; PCAOB, 2010), in the
preparation of management's discussion and analysis (CICA,
2009), in the disclosure of inside trading information (FCA,
2013), in the evaluation of ?nancial statement errors (Pozen,
1
As required by the Continuous Disclosure (CD) Requirements which consist of
Australian Securities Exchange Listing Rule 3.1 and 3.1A and Chapter 6 of the Cor-
porations Act.
2
In Australia, company secretaries are part of the executive management team.
One of their key responsibilities is to advise the board on the company's statutory
disclosure obligations. They are considered to be of?cers of the company, and
therefore, can be held personally liable and subject to civil penalties in the event
their company is found to have contravened the CD provisions of the Corporations
Act. In the US, company secretaries are referred to as corporate secretaries.
3
In Blyth v Birmingham Waterworks Co (1856) 11 Ex Ch 781. The court found
that the defendants could only have been negligent if they had failed to do what a
reasonable person would do in the circumstances. This case de?ned negligence as
“the omission to do something which a reasonable man, guided upon those con-
siderations which ordinarily regulate the conduct of human affairs, would do, or
doing something which a prudent and reasonable man would not do. The de-
fendants might have been liable for negligence, if, unintentionally, they omitted to
do that which a reasonable person would have done, or did that which a person
taking reasonable precautions would not have done.”
4
TSC Industries Inc v Northway Inc 426 US 438 (1976). Also, see Mitchell v Texas
Gulf Sulphur Co., 446 F2.D 90, at 99e100 (10th Circuit, 1971) and Escott et al. v.
BarChris Construction Corporation et al., 283 Fed. Supp. (District Ct. S.D. New York,
1968) p. 681.
D. Mayorga, K.T. Trotman / Accounting, Organizations and Society xxx (2015) 1e13 2
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
2008) and in Australia's continuous disclosure regime (ASX,
2013).
5
Continuous disclosure is a central tenet of the Australian regula-
tory landscape for listed public companies. It is primarily based on a
combination of Australian Securities Exchange (ASX) requirements
and the legislative provisions of Australia's Corporation Act. Of in-
terest to this study is Australian Securities Exchange Listing Rule 3.1
(ASX LR3.1) which requires an entity to immediately disclose infor-
mation that a reasonable person would expect to have a material
effect on the price or value of the entity's securities (referred to as
“market sensitive information”). Information is market sensitive if it
would, or would be likely to, in?uence persons who commonly
invest in securities in deciding whether to acquire or dispose of the
securities. The ASX has acknowledged that determining whether
information is market sensitive can be dif?cult in practice as listed
entities are “effectively requiredtopredict howinvestors will react to
particular information when it is disclosed” (ASX, 2013, p. 10). Given
this dif?culty, the ASX suggests that managers may ?nd it helpful to
take the perspective of a reasonable investor when faced with
continuous disclosure decisions (ASX, 2013).
2.2. Directional goals and managers' disclosure judgments
Managers have economic incentives to disclose information
opportunistically (e.g., Aboody & Kasznik, 2000) including with-
holding bad news (e.g., Kothari, Shu, &Wysocki, 2009). For example,
managers have incentives related to stock valuation, career concerns
and external reputation, and these incentives can drive managers to
delay disclosure of bad news in the hope that the ?rm's performance
will improve before the next required information release, to allow
further study and interpretation of the information, or to package
the bad news with other disclosures (Graham, Harvey, & Rajgopal,
2005). In addition, managers have preferences to maintain pre-
dictability in earnings and ?nancial disclosures (Graham et al.,
2005). Managers are likely to use these preferences as a starting
point, or judgmental anchor, when assessing new disclosure infor-
mation and subsequently adjust away fromtheir anchor to take into
account the speci?cs of the new disclosure context.
Motivated reasoning research shows that directional goals bias
individuals' beliefs about the perceived likelihood of events (Klein
& Kunda, 1992; Kunda, 1990). Desirable events are perceived as
more likely to occur when individuals make a subjective interpre-
tation of the events occurring (Irwin, 1953; Irwin & Snodgrass,
1966; Marks, 1951). For example, individuals can interpret their
belief that an event has a 60 percent probability of happening to
mean that the event is either slightly likely, or somewhat likely, to
happen, depending on whether they want to view it as likely
(Kunda, 1990, p. 488). Individuals' interpretation of an event, in
turn, can affect their willingness to assume and bet that the event
will occur (Arrowood & Ross, 1966). Several studies in accounting
provide evidence that the decisionprocesses of managers, investors
and traders are susceptible to directional reasoning mechanisms
(e.g., Hales, 2007; Han & Tan, 2010; Seybert & Bloom?eld, 2009;
Tayler, 2010). Consistent with motivated reasoning theory, this
suggests that managers' directional goals may bias their judgments
about the likelihood of a negative change in earnings expectations
as long as their ?nal disclosure recommendations appear reason-
able and justi?able based on the available information.
Directional goals are also likely to bias managers' disclosure
judgments when the disclosure issue is ambiguous. Psychological
research indicates that ambiguous information allows for multiple
interpretations (e.g., Montgomery, 1989) and therefore makes it more
likely that directional goals will exert in?uence on individuals' judg-
ments (Schweitzer & Hsee, 2002). Even when individuals have goals
to process information objectively, they may be unable to do so as
their pre-existing directional preferences may foster more extensive
defensive processingof ambiguous information(Liberman&Chaiken,
1992). Consistent with this, Hales (2007) demonstrates that when
investors were only given explicit incentives to be accurate in their
earnings forecasts, their directional goals still biased their forecasts.
Consequently, we expect that managers’ directional goals to withhold
badnews will leadtoa self-serving“donot disclose” recommendation
as a starting point for a new ambiguous disclosure matter.
2.3. Effect of perspective taking on managers' disclosure judgments
Whenmanagers are facedwitha decisiononwhether information
needs todisclosed, theyshouldconsider whether the informationwill
in?uence a reasonable investor's investment decision(ASX, 2013). An
important question, however, is whether managers can effectively
predict how investors will react to particular information when it is
disclosed. The psychology literature has long recognized that in-
dividuals' social judgments tend to be egocentrically biased (e.g.,
Davis, 1983; Epley et al., 2004). One way for individuals to overcome
their egocentric biases and tailor their behaviors to others' expecta-
tions is through perspective taking (Batson, Early, & Salvarani, 1997;
Davis, 1983; Davis, Conklin, Smith, & Luce, 1996; Epley & Caruso,
2009).
6
Considering others' perspectives has been found to increase
the likelihood of helping another person in need (Batson, 1994),
reduce the use of stereotypes when forming impressions (Galinsky &
Moskowitz, 2000), increase negotiation effectiveness (Neale &
Bazerman, 1983) and diminish a variety of problematic egocentric
biases in judgment (Savitsky, Van Boven, Epley, & Wight, 2005;
Wade-Benzoni, Tenbrunsel, & Bazerman, 1996).
The anchoring and adjustment model of perspective taking
(Epley & Gilovich, 2004; Epley et al., 2004) predicts individuals
adopt others' perspectives by initially anchoring on their own more
readily accessible perspective and subsequently adjusting to ac-
count for differences between themselves and others until a plau-
sible estimate is reached (Epley & Caruso, 2009; Epley & Gilovich,
2006; Epley et al., 2004; Nickerson, 1999; Tversky & Kahneman,
1974). However, these adjustments tend to be insuf?cient (Epley
et al., 2004; Tversky & Kahneman, 1974), and, as a result, many
assessments of others’ perspectives remain egocentrically biased.
Psychology research suggests that factors facilitating careful
thought will decrease individuals' egocentric bias in perspective
taking (Epley et al., 2004). For example, Epley, Caruso, and Bazerman
(2006) demonstrate that when individuals are explicitly asked to
consider another's thoughts, they are more likely to adopt another's
perspective than when individuals are not explicitly asked. In an
auditingcontext, Altieroet al. (2015) ?ndthat auditors, whoengage in
investor-minded tasks prior to making materiality judgments, pro-
vide better quality judgments than auditors who do not.
5
In Australia, the Federal Court of Australia has considered expert witness tes-
timony in determining whether a reasonable person would have expected disclo-
sure. That is, if the information had been disclosed, would it have had a material
effect on the value of the company's share value? Experts used to provide expert
testimony have included experienced share portfolio managers, stockbrokers, an-
alysts, capital market academics and economists. For example, in Australian Secu-
rities & Investments Commission v Fortescue Metals Group Ltd [No 5] [2009] FCA 1586
(23 December 2009), the judge, J. Gilmour, considered the relevance of expert
opinion of statisticians, stockbrokers and analysts in determining contraventions of
CD provisions.
6
In this study, perspective taking refers to the ability to “intuit”, as accurately as
possible, another person's thoughts, feelings, attitudes, interests, or concerns in a
particular situation (Chartrand, 1999; Davis, 1983; Epley & Caruso, 2009; Epley,
Savitsky, & Gilovich, 2002).
D. Mayorga, K.T. Trotman / Accounting, Organizations and Society xxx (2015) 1e13 3
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
In our study, we explicitly prompt managers to consider the
perspective of a reasonable investor. Taking this perspective should
increase managers' attention to a reasonable investor's disclosure
preferences. Managers should also give greater consideration to the
ways in which a reasonable investor might perceive the disclosure
issue differently. This consideration is likely to motivate managers
to adjust from their own personal disclosure preferences and thus
lead to less egocentric disclosure recommendations. For example,
as investors typically judge more corporate disclosure as better
than less (e.g., Hermalin & Weisbach, 2012), managers are more
likely to consider reasons supporting disclosure when they are
explicitly prompted to consider a reasonable investor's perspective.
In turn, these managers will make disclosure recommendations
which are more supportive of disclosing a negative change in
earnings expectations compared to managers who are not explic-
itly prompted. Our expectations are summarized below.
Hypothesis 1. Managers are more likely to recommend disclosure
of a negative change in earnings expectations when they are
prompted to take the perspective of a reasonable investor than
when they are not.
2.4. Firm's prior disclosure policy
Psychology research suggests that there are factors that inhibit
the anchoring and adjustment model of perspective taking (Epley
et al., 2004). Of particular relevance to our study is the effect of
the ?rm's prior disclosure policy which develops as a result of
institutional and market factors as well as ?rm speci?c factors
including ?rm traditions and internal politics (Gibbins et al., 1990;
Holland, 2005; Holland & Stoner, 1996), personal preferences
(Bamber et al., 2010; Brochet, Faurel, &McVay, 2011) and disclosure
preferences instituted by the board (Caskey, Nagar, & Petacchi,
2010; Richardson, Tuna, & Wysocki, 2003). To the extent that
managers take into account the ?rm's prior disclosure policy, it is
likely to in?uence their perspective taking processes.
2.5. Effect of ?rm's prior disclosure policy when there is a
reasonable investor prompt
Epley et al. (2004) suggest that individuals engage in anchoring
and adjustment only when it is clear that their views represent a
reasonable starting place. In situations where individuals' own
perspective is irrelevant, they state that quite different perspective
taking processes may be involved. For example, when managers
know their ?rm's prior disclosure policy is biased towards no
disclosure, they are more likely to anchor on their ?rm's prior
disclosure policy when assessing the perspective of a reasonable
investor. Further, managers are likely to insuf?ciently adjust from
this anchor point because knowledge of ?rm's preferred policy
yields an acceptable disclosure recommendation without too much
cognitive thought. In particular, psychological research indicates
that the adjustment process is effortful and individuals tend to
terminate the adjustment process once a plausible judgment is
made (Epley & Gilovich, 2006). This implies that knowledge of the
?rm's preference will diminish managers' willingness to exert extra
cognitive thought to seek a more objective disclosure judgment.
Consequently, we expect managers' consideration of a reasonable
investor's perspective will be less when they know the ?rm's prior
disclosure policy is biased towards no disclosure as their anchoring
and adjustment process will be in?uenced by knowledge of the
?rm's disclosure preferences. Thus, relative to when the ?rm's prior
disclosure policy is unknown, we expect that managers will be less
likely to recommend disclosure when they are prompted to take a
reasonable investor perspective and the ?rm's prior disclosure
policy is known. Our expectationis shownas the solid line inFig. 1 as
an upward sloping line fromthe reasonable investor prompt known
condition to the reasonable investor prompt unknown condition.
2.6. Effect of ?rm's prior disclosure policy when there is no
reasonable investor prompt
Motivated reasoning theory indicates that individuals arrive at
their preferred outcomes subject to their ability to construct
seemingly rational justi?cations for their choices and decisions
(Kunda, 1990) and that individuals engage in the minimum of
reasoning to reach their preferred outcome even if more bias would
still be viewed as reasonable (Boiney, Kennedy, & Nye, 1997).
Further, psychological research suggests that when individuals face
situations with greater uncertainty surrounding the appropriate
decision, they may ?nd it easier to justify a preferred outcome
(Hsee, 1995, 1996; Schweitzer & Hsee, 2002).
Uncertainty surrounding the appropriate disclosure recommen-
dation can be in?uenced by knowledge of the ?rm's prior disclosure
policy. When managers knowthat the board has expressed concerns
about management's prior history of disclosing information that is
dif?cult toquantify, there is more certaintyabout the ?rm's disclosure
preferences, and correspondingly less of a need for managers to
engage in a mentally costly evaluation of the evidence to arrive at a
justi?able disclosure recommendation, inthis case a “donot disclose”
recommendation. On the other hand, when managers do not know
the ?rm's prior disclosure policy, there is less certainty as to whether
the board will support or oppose disclosure for the new disclosure
issue andmanagers will needtodevote extra mental thought toarrive
at a defensible disclosure recommendation. Managers are therefore
likely to make a more thorough examination of the evidence, irre-
spective of its direction, to prepare themselves for a variety of re-
actions totheir recommendations. The motivatedreasoningliterature
indicates that deeper processing of both sides of an issue includes
automatic goal-driven processes that bias individuals toward reach-
ing and justifying preferred outcomes (Kunda, 1990; Peecher et al.,
2010). Managers' more thoughtful, but biased, information process-
ing is therefore likely to result ina “donot disclose” recommendation.
This discussion implies that managers who do not know the ?rm's
prior disclosure policy are likely to make stronger “do not disclose”
recommendations than managers who know that the ?rm's prior
disclosure policy is biased towards no disclosure. This would suggest
that the dotted line in Fig. 1 slopes downwards from left to right.
However, researchinaccountability(see Lerner andTetlock(1999)
for a review), predecisional distortion (e.g., Ricchiute, 2004; Wilks,
2002) and motivated reasoning (e.g., Cloyd & Spilker, 1999) demon-
strate that knowledge of a relevant audience's views can signi?cantly
affect accounting professionals' decision making. Although this
researchsuggests that knowledge of the ?rm's prior disclosure policy
will impact managers' disclosure recommendations, overall it is not
clear whether managers will be less or more likely to recommend
disclosure when they are not prompted to take the perspective of a
reasonable investor and know the ?rm's prior disclosure policy
compared to when they do not know. In light of these competing
predictions, no differences are predicted between the known and
unknownconditions whenthereis noprompt. ThedottedlineinFig. 1
illustrates the graphical representation of our expectation.
As depicted in Fig. 1, we predict an interaction between the
reasonable investor prompt and ?rm's prior disclosure policy such
that the difference in managers' disclosure recommendations is
greater whenthe ?rm's prior disclosure policyis unknownthanwhen
it is known. We formally state this interaction hypothesis below:
Hypothesis 2. The effect of a prompt to take the perspective of
reasonable investor on managers' disclosure recommendations is
D. Mayorga, K.T. Trotman / Accounting, Organizations and Society xxx (2015) 1e13 4
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
greater when the ?rm's prior disclosure policy is unknown than
when it is known.
3. Method-Experiment One
3.1. Participants
Sixty senior managers and directors who contribute to their
public companies' ?nancial information disclosure decision-
making processes participated in the experiment. The authors
personally recruited potential participants over an eight month
period by contacting professional associations, university advisory
and alumni networks and industry contacts as well as by directly
contacting top management of public ?rms. From these contacts,
the authors mailed 89 research packets. Sixty senior managers and
directors completed and returned the research materials, for a
response rate of 67 percent.
7
Participants were promised con?-
dentiality of information and an A$50 (approximately US$35 at the
time) gift voucher for participating in the study.
The participants comprised 40 company secretaries, nine CFOs/
?nancial controllers, ?ve directors, ?ve CEOs and one commercial/
investor relations manager.
8
Sixty-one percent of the participants
have signi?cant work experience (e.g., greater than 20 years) with a
?rm listed in the Australian Securities Exchange (ASX) top 200
listed companies by way of market capitalization. The other 39
percent of participants had a minimum of 10 years of signi?cant
work experience.
9
The participants had an average rating of 8.14
(median ¼ 8, range 2e10) on a 10-point scale ranging from 1 (‘not
at all familiar’) to 10 (‘very familiar’) in terms of their familiarity
with making CD decisions. In response to the question “How many
times have you been involved in making similar types of ASX
Listing Rule 3.1 and 3.1A decisions?”, seven percent of the partici-
pants reported more than a 100 times, 14 percent reported 50 to
100 times, eighteen percent reported 20 to 49 times, 18 percent
reported ten to 19 times, and 43 percent reported two to nine
times.
10
In sum, participants were highly experienced managers
and very experienced at this task.
3.2. Case materials
The case was adapted with signi?cant modi?cations from Tan
and Trotman (2010). At the beginning of the case, managers learn
the following:
In this study, you will be asked to assess a speci?c matter that has
recently come to the attention of management and provide to the
Board of Directors a recommendation based on whether you
believe [a reasonable investor would expect that] the information
should be disclosed.
11
The ‘speci?c matter’ deals with whether information regarding
a probable negative change in forecast revenue requires immediate
disclosure under Australia's CD regulation.
The case materials contain selected historical ?nancial results
for the company over a two-year period (revenue, operating pro?t,
EPS), and projections for the current year (forecast revenue, fore-
cast operating pro?t, forecast EPS and analysts' consensus EPS
forecast). This is followed by details of the disclosure matter which
involves a probable negative change in forecast revenue for a major
new contract with a government department for leasing of satel-
lites for high-bandwidth. The contract includes signi?cant penalty
clauses related to satellite downtime. The company previously
released a revenue forecast for the contract for the current year
Fig. 1. This ?gure illustrates the study's predictions of the joint effects of the reasonable investor prompt and ?rm's prior disclosure policy on managers' disclosure judgments.
Prompt ¼ participants are prompted to take the perspective of a reasonable investor. No Prompt ¼ participants are not prompted to take the perspective of a reasonable investor.
Known ¼ participants are told that the ?rm's prior disclosure policy is biased towards no disclosure. Unknown ¼ participants are not given information about the ?rm's prior
disclosure policy. Disclosure Judgment ¼ more or less likely to recommend disclosure of a probable negative change in the company's earnings expectations.
7
Prior to data collection, we decided to collect a minimum of ?fteen observations
per cell given the challenges in recruiting professional participants who had
experience in making continuous disclosure decisions for ASX listed ?rms. We
terminated data collection at the end of eight months as this study formed part of
one of the author's PhD dissertation with time deadlines.
8
These positions generally sit on the ?rm's Disclosure Committee (Kwak, Ro, &
Suk, 2012; Mayorga, 2013). Disclosure committees manage the process of making
?nancial information disclosure decisions. If the ?rm doesn't have a disclosure
committee, these managers may be involved in the disclosure process indirectly
through their role as an internal governance advisor to the CEO and board.
9
Once participants had returned the research materials, they emailed the re-
searchers stating that they had completed the case so that a gift certi?cate could be
sent in appreciation of them taking part in the research. Hence, the researchers
have the names of all the study's participants. To calculate their work experience
level, we accessed external sources (e.g., annual reports, LinkedIn). For 92% of the
sample, we are able to report actual experience levels. For the remaining 8%, we are
only able to report a minimum of 10 years work experience. For con?dentiality
reasons, we could not link names to individual research instruments.
10
Participants' current position, familiarity with making CD decisions and the
number of times they had been involved in making similar types of CD decisions
did not differ signi?cantly (p > 0.10) across the four experimental conditions.
Participants' current position did not interact signi?cantly with any of the inde-
pendent variables in the study.
11
The phrase in brackets was only given to the reasonable investor prompt
conditions.
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with no allowance for penalties. Management has received pre-
liminary evidence suggesting that downtime has exceeded the
permitted level and believes it is probable that some penalty costs
will be incurred but they are uncertain of the extent of these po-
tential penalty payments.
Participants are given informationwhich shows various revenue
and earnings per share projections after recognizing estimates of
penalties ranging from 100 percent to 33.3 percent of the potential
penalty and the estimated decrease in forecasted EPS for the
different levels of penalties. Depending on the assumption a
participant adopts with respect to potential penalties, the impact
on projected operating pro?t will range fromnil decrease (assumes
no penalty) to an eight percent decrease (assumes the maximum
amount of penalties). Thus, the case requires participants to exer-
cise signi?cant judgment in determining whether the matter is
quantitatively and/or qualitatively material. For example, recog-
nizing 33.3 percent of potential penalties is three percent of pro-
jected operating income and it moves the company's forecasted EPS
from above to below the analysts' consensus EPS and results in a
change in earnings trends from prior years. Recognition of one-
third of the penalties also affects ratios used to evaluate the com-
pany and is a change from the projected revenue disclosures made
earlier in the year. The participants need to consider both quanti-
tative and qualitative materiality.
Evidence items were facts drawn from the background infor-
mation about the client and details of the speci?c disclosure matter
which participants read prior to evaluating the evidence.
12
The case
consisted of ten evidence items supportive of disclosure and ten
items not supportive of disclosure.
3.3. Design
This experiment employed a 2 x 2 between-subjects factorial
design. The ?rst independent variable was Reasonable Investor
Prompt (Prompt versus No Prompt). Both conditions were instructed
to assume the role of company secretary, assess a potential
disclosure matter and provide to the board of directors a recom-
mendation on whether the information should be disclosed. Par-
ticipants assigned to the no prompt condition were asked to assess
a speci?c disclosure matter that has come to the attention of
management and provide a recommendation to the Board of Di-
rectors based on “whether you believe the information should be
disclosed”. Participants assigned to the prompt condition were
asked to “step into the shoes of a reasonable investor” and assess a
speci?c disclosure matter that has come to the attention of man-
agement and provide a recommendation to the Board of Directors
based on “whether you believe a reasonable investor would expect
that the information should be disclosed”. We chose the term ‘step
into the shoes of a reasonable investor’ based on the terminology
used in Pozen (2008). To heighten participants' awareness that
their disclosure judgments should be based on whether a reason-
able investor would expect disclosure, the case instructions
emphasized for the prompt condition that it is important to react to
the disclosure matter “as though you are providing a disclosure
recommendation based on what you believe a reasonable investor
would provide”.
The second independent variable was the Firm's Prior Disclosure
Policy (Known versus Unknown). Participants assigned to the known
condition read the following immediately before reviewing the
background information and evaluating evidence
13
:
At the last Board of Directors' meeting, the board of Germa Satellite
Limited expressed its concern that management has been overly
vigilant and conservative in disclosing information in situations
where it was dif?cult to quantify the magnitude of the event. All the
directors indicated that releasing speculative information may
potentially harm the ?rm's share price for no underlying economic
reasons.
The words “at the last Board of Directors' meeting” were
included in the ?rm's prior disclosure policy to ensure that the
information contained in the ?rm's prior disclosure policy
description is independent of the information on the new disclo-
sure matter. This is important as the study investigates whether a
prior disclosure policy in?uences how new disclosure decisions
are impacted.
To heighten their awareness of the board's concern (see Peecher,
1996; Wilks, 2002), participants are then asked to list three reasons
why a listed company would prefer to delay disclosure of infor-
mation where it is dif?cult to quantify the magnitude of the event
14
and to rank these reasons in order of their impact on managers'
disclosure judgments with the ?rst reason being the most in?u-
ential and the third being the least in?uential. Participants assigned
to the unknown conditions are not given the ?rm's prior disclosure
policy in their research packet.
15
3.4. Procedures
Individuals who had agreed to participate in the study were
randomly assigned to one of the four experimental conditions. Each
participant received by mail a numbered (for randomization and
control purposes) research packet. On the outside of the research
packet there were written instructions for the participant which
stated the importance of completing the task in one sitting and
completing the task individually and without discussion with col-
leagues. The instructions stated that the participant was one of a
small group of professionals involved in this important study and
that their participation was highly valued (Gibbins & Trotman,
2002). Participants then read the background information about
the company, the speci?c disclosure issue, the revenue projections
and the potential associated revenue write-downs.
Participants ?rst read and evaluated 20 evidence items related to
whether a revised earnings forecast was warranted under ASX's
Listing Requirements.
16
These items indicated reasons managers
may disclose or not disclose the speci?c disclosure issue. For
12
The evidence items were developed based on the following sources: Tan and
Trotman (2010), a review of Australian, US and UK case law on the application of
an obligation to disclose material information where that information is subject to
uncertainty, and a review of enforcement actions for breaches of CD requirements
undertaken by Australian Securities and Investment Commission.
13
Tetlock, Skitka, and Boettger (1989), Green, Visser, and Tetlock (2000) and
Wilks (2002) use the following words “insuf?ciently [overly]”, “strongly” and
“consistently” respectively to increase the participants awareness of their evalua-
tive audience's view in their experimental task. Consistent with this research, this
study uses an adverb, ‘overly’, to heighten participants' awareness of the ?rm's
prior disclosure policy.
14
All reasons provided by managers suggest that the ?rm's prior disclosure policy
manipulation induced them to believe that the ?rm's prior disclosure policy sup-
ports less disclosure.
15
In addition to the two independent variables, four random orderings of evi-
dence were constructed and fully crossed with the four conditions to reduce po-
tential order effects. This resulted in 16 research instruments. This order variable is
non-signi?cant in the ANOVA analyses (p > 0.10) and does not interact with any
other variables in the model. Thus, this variable is not further discussed.
16
ASX LR3.1 requires that once an entity is or becomes aware of any information
concerning it that a reasonable person would expect to have a material effect on the
price or value of the entity's securities, the entity must immediately tell ASX that
information unless speci?c conditions apply including that ‘a reasonable person
would not expect the information to be disclosed’.
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Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
example, evidence items included “Last year a competitor reported
an earnings' downgrade due to penalty costs associated with
downtime” and“There is considerable uncertaintyas towhat will be
the total downtime for the year for this particular contract”. Evi-
dence items were evaluated individually using a 15-point bipolar
evidence evaluation scale with the À7 endpoint labeled “extremely
supportive of NOT disclosing immediately” to the 7 endpoint
labeled “extremely supportive of disclosing immediately” and the
center point labeled “neutral”. Participants then made disclosure
recommendations on a 15-point bipolar disclosure judgment scale
with the À7 endpoint labeled “clearly not required to be disclosed
immediately” and the 7 endpoint labeled “clearly required to be
disclosed immediately” and the center point labeled “completely
uncertain”. This disclosure recommendation was used for testing
Hypothesis 1 and Hypothesis 2. The labeling on both scales followed
Tan(1995), Wilks (2002) and Ricchiute (2004) withmodi?cations to
the wording to suit the task context. Following the disclosure
recommendation, participants rated the importance of each evi-
dence iteminreaching their disclosure recommendationusing a 10-
point response scale with the 1 endpoint labeled “not at all impor-
tant” and the 10 endpoint labeled “very important”. This measure
was used in additional analysis to further explain our results. Spe-
ci?cally, we examine whether their ratings of the importance of
eachevidence itemintheir ?nal disclosure judgment differ between
experimental conditions (Tables 3 and 4). Finally, participants
completed a questionnaire which included demographic questions
and manipulation check questions.
17
4. Results-Experiment One
4.1. Manipulation checks
To examine the effectiveness of the ?rm's prior disclosure policy
manipulation, managers were asked to indicate the board's concern
that management had been: (a) overly vigilant and conservative in
disclosing information that was dif?cult to quantify or (b) no
concern was mentioned. Twelve of the 60 participants failed to
provide correct answers to this manipulation check.
18
As the in-
ferences drawn from this study do not change when these 12
managers are excluded, they are included in the analysis.
As the securities exchange listing rules relate disclosure to what
a reasonable person would expect direct questions on whether a
reasonable investor perspective is taken are likely not to be very
different between conditions.
19
Thus we asked managers to indi-
cate whether they had a particular type of investor in mind when
completing the task. If they responded “yes”, we asked participants
to describe the type of investor. Sixty-eight percent stated that they
considered retail investors and thirty-two percent stated they
considered institutional investors in their disclosure decision
making process. A chi-square test comparing whether managers in
the prompt conditions were more likely to think of a particular type
of investor when completing the task than managers in the no
prompt conditions found a signi?cant effect (x
2
(1)
¼ 3.068,
p ¼ 0.040). Thus, on average, while managers believed they
considered disclosure recommendations from a reasonable
investor perspective, it was more likely that the managers in the
prompt conditions actually considered a reasonable investor's
perspective.
4.2. Hypothesis tests
Table 1 shows descriptive statistics across experimental condi-
tions for managers' disclosure judgments. The means for the prompt
unknown, prompt known, no prompt known, and no prompt un-
known conditions are À0.20, À1.80, À2.80 and À4.73 respectively.
The overall mean is À2.38. Fig. 2 presents the results graphically and
Table 2, Panel A reports results of an analysis of variance (ANOVA).
We ?nd a signi?cant main effect of the reasonable investor prompt
(F
1,56
¼ 8.459, p ¼ 0.005, two-tailed) and a marginally signi?cant
reasonable investor prompt by ?rm's prior disclosure policy inter-
action (F
1,56
¼ 3.449, p ¼ 0.069, two-tailed).
Table 2, Panel B reports our planned contrast tests. Consistent
with hypothesis 1 managers are more likely to recommend
disclosure of a negative change in earnings expectations when they
are prompted to take the perspective of a reasonable investor
(combined mean ¼ À1.00, Table 1) than when they are not
prompted (combined mean ¼ À3.77, Table 1) (t
(56)
¼ 2.908,
p ¼ 0.003, one-tailed, Table 2).
20
Hypothesis 2 predicts that the effect of the prompt to take the
Table 1
Experiment One: managers' disclosure judgments.
Means (std. dev.) [n] of the effects of reasonable investor prompt and
knowledge of the ?rm's prior disclosure policy on managers' disclosure
judgments
Reasonable
investor prompt
If participants know the ?rm's prior disclosure policy
Known Unknown Combined
Prompt À1.80 À0.20 À1.00
(3.82) (3.91) (3.89)
[15] [15] [30]
No Prompt À2.80 À4.73 À3.77
(4.23) (2.55) (3.57)
[15] [15] [30]
Combined À2.30 À2.47 À2.38
(3.99) (3.98) (3.68)
[30] [30] (60)
This table presents descriptive statistics for managers' continuous disclosure judg-
ments. Managers recommended on a 15-point scale whether disclosure of a revised
earnings forecast is required at this time (À7 ¼ clearly NOT REQUIRED TO BE DIS-
CLOSED immediately to 7 ¼ clearly REQUIRED TO BE DISCLOSED immediately,
center point labeled “completely uncertain”).
Prompt ¼ participants are prompted to take the perspective of a reasonable
investor.
No Prompt ¼ participants are not prompted to take the perspective of a reasonable
investor.
Known ¼ participants are told that the ?rm's prior disclosure policy is biased to-
wards no disclosure.
Unknown ¼ participants are not given information about the ?rm's prior disclosure
policy.
17
Feedback received from participants suggests that completion of the case ma-
terials ranged from 45 min to one hour.
18
Nine participants who failed this manipulation check were in the unknown
conditions for the ?rm's prior disclosure policy variable.
19
We asked participants to indicate the degree to which they made the recom-
mendation based upon their beliefs of a reasonable investor, on a 10-point scale
ranging from 1 (“not at all”) to 10 (“very much”). Participants in the no prompt
conditions had an average rating of 7.20 (s.d. 2.52) and participants in the prompt
conditions had an average rating of 7.27 (s.d. 1.64) with the differences not sig-
ni?cant (p > 0.10).
20
We also conducted an untabulated ANOVA for evidence evaluation as the
dependent variable. The means for the prompt unknown, prompt known, no
prompt known and no prompt unknown conditions are À1.05, À1.24, À1.73
and À2.41 respectively. Neither reasonable investor prompt (p ¼ 0.162), nor ?rm's
prior disclosure policy (p ¼ 0.709) or their interaction (p ¼ 0.505) are statistically
signi?cant. Using the same contrasts as above, we ?nd marginal support for the
proposition that managers evaluate evidence as more supportive of disclosure
when they are prompted to take a reasonable investor perspective than when they
are not (t
(56)
¼ 1.417, p ¼ 0.081, one-tailed). We do not ?nd support for the
reasonable investor prompt by ?rm's prior disclosure policy interaction
(t
(56)
¼ 0.672, p ¼ 0.253, one tailed). For the simple main effect tests, we ?nd
marginal support in the unknown condition (t
(56)
¼1.477, p ¼ 0.073, one-tailed) but
not in the known condition (p ¼ 0.300, one-tailed).
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Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
perspective of a reasonable investor on managers' disclosure rec-
ommendations is greater when the ?rm's prior disclosure policy is
unknown than when it is known. The difference in managers'
disclosure recommendations between the two prompt conditions
is 4.53 (i.e., À4.73À(À0.20) when the ?rm's prior disclosure policy
is unknown and 1.00 (i.e., À2.80À(À1.80) when it is known. A
planned contrast test indicates that, as predicted by Hypothesis 2,
this difference is signi?cant (t
(56)
¼ 1.857, p ¼ 0.035, one-tailed,
Table 2 Panel B). Simple main effect tests (also shown in Table 2
Panel B) show that the prompt only has a signi?cant effect on
managers' disclosure judgments in the unknown condition
(t
(56)
¼3.370, p < 0.001, one-tailed) and not in the known condition
(t
(56)
¼ 0.743, p ¼ 0.230, one-tailed).
4.3. Additional analysis
Psychology research suggests that individual's pre-existing be-
liefs and preferred outcomes are “sticky” as a result of biased in-
formation processing (for a review of this research see Koonce &
Mercer, 2005). Individuals tend to be more critical of evidence
which discon?rms their preferred beliefs or outcomes (Ditto,
Munro, Apanovitch, Scepansky, & Lockhart, 2003; Edwards &
Table 2
Experiment One: ANOVA and planned contrasts for the effects of reasonable investor prompt and knowledge of the ?rm's prior disclosure policy on managers' disclosure
judgments.
PANEL A: Analysis of Variance
Source df Mean Square F-statistic Two-Sided p-value
Reasonable Investor Prompt 1 114.817 8.459 0.005
Firm's Prior Disclosure Policy 1 0.417 0.031 0.862
Reasonable Investor Prompt x Firm's Prior Disclosure Policy 1 46.817 3.449 0.069
Error 56 13.574
Reasonable Investor Prompt (prompt versus no prompt)
Firm's Prior Disclosure Policy (known to be biased towards no disclosure versus unknown)
PANEL B: Planned Contrasts
Hypothesized Contrasts df t One-Sided p -value
H
1
: Managers are more likely to recommend disclosure of a negative change in
earnings expectations when they are prompted to take the
perspective of a reasonable investor than when they are not.
56 2.908 0.003
H
2
: The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations is greater when the
?rm's prior disclosure policy is unknown than when it is known.
(m
PU
À m
NoPU
) > (m
PK
À m
NoPK
)
56 1.857 0.035
Simple Main Effects of Reasonable Investor Prompt
The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations when the ?rm's prior
disclosure policy is known.
56 0.743 0.230
The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations when the ?rm's prior
disclosure policy is unknown.
56 3.370
Security laws and accounting standards suggest that reasonable investors' expectations are an important
consideration for disclosure judgments. Regulators have expressed concerns that many disclosure
judgments are made without adequate consideration of how investors would evaluate the information.
However, the psychological literature suggests that individuals may face difficulties considering the facts
from another's perspective. We conduct two experiments to examine whether prompting managers to
take the perspective of a reasonable investor affects their disclosure recommendations of a probable
negative change in their company's earnings expectations, and whether this effect is impacted by the
firm's prior disclosure policy (known that its past preference to be biased towards no disclosure versus
unknown). We find that experienced managers are more likely to recommend disclosure when they are
prompted to take the perspective of a reasonable investor than when they are not and this effect is
stronger when the firm's prior disclosure policy is unknown.
The effects of a reasonable investor perspective and ?rm's prior
disclosure policy on managers' disclosure judgments
*
Diane Mayorga
*
, Ken T. Trotman
**
School of Accounting, UNSW Australia, Australia
a r t i c l e i n f o
Article history:
Received 25 June 2013
Received in revised form
16 October 2015
Accepted 17 October 2015
Available online xxx
Keywords:
Disclosure policy
Perspective taking
Reasonable investor
Reasonable person
a b s t r a c t
Security laws and accounting standards suggest that reasonable investors' expectations are an important
consideration for disclosure judgments. Regulators have expressed concerns that many disclosure
judgments are made without adequate consideration of how investors would evaluate the information.
However, the psychological literature suggests that individuals may face dif?culties considering the facts
from another's perspective. We conduct two experiments to examine whether prompting managers to
take the perspective of a reasonable investor affects their disclosure recommendations of a probable
negative change in their company's earnings expectations, and whether this effect is impacted by the
?rm's prior disclosure policy (known that its past preference to be biased towards no disclosure versus
unknown). We ?nd that experienced managers are more likely to recommend disclosure when they are
prompted to take the perspective of a reasonable investor than when they are not and this effect is
stronger when the ?rm's prior disclosure policy is unknown.
© 2015 Elsevier Ltd. All rights reserved.
1. Introduction
Securities laws and accounting standards around the world
suggest that managers consider the perspective of a ‘reasonable
investor’ when they evaluate whether their listed company has an
obligation to inform the investing public of events and circum-
stances that could materially affect the price of their ?rm's
securities. In fact, the words ‘reasonable person’ and ‘reasonable
investor’ are pervasive in the legislation of many countries
including Australia, UK and USA. However, regulators are
concerned that managers are making many disclosure judgments
without fully considering the disclosure matter from a benchmark
of how a reasonable investor would evaluate the information
(Pozen, 2008, p. 80). Research also indicates that managers'
disclosure judgments are affected by their ?rm's preferences and
experiences for the way disclosure is managed (hereafter referred
to as the ‘?rm's prior disclosure policy’) (e.g., Bamber, Jiang, &
Wang, 2010; Gibbins, Richardson, & Waterhouse, 1990; Holland,
2005).
Given the requirement to consider the viewpoint of a reasonable
investor when making disclosure decisions, our study investigates
whether managers are more likely to recommend disclosure of a
probable negative change in their company's earnings expectations
when they are prompted to take the perspective of a reasonable
investor and whether this effect is increased or decreased when
managers know the ?rm's prior disclosure policy has been biased
towards no disclosure. Our study examines the research questions
in the context of Australia's Continuous Disclosure (‘CD’) environ-
ment although it is noted that CD obligations are also relevant to
many other countries including Canada, Hong Kong, New Zealand,
Singapore and the UK. Australia's CD regulation requires that
companies promptly disclose information that a reasonable person
would expect to have a material effect on the price or value of their
securities unless certain exceptions are satis?ed including that a
*
We thank Robert Bloom?eld (editor), two anonymous reviewers, Hun-Tong Tan,
and workshop participants at UNSW Australia for their helpful suggestions and
comments. We also thank the managers who participated in our study. The ?rst
author gratefully acknowledges the helpful comments from her dissertation ex-
aminers and the ?nancial assistance of the AFAANZ/CPA/Australia/ICAA/NIA PhD
Scholarship.
* Corresponding author. School of Accounting, UNSW Business School, UNSW
Australia, Sydney, NSW 2052, Australia.
** Corresponding author. School of Accounting and Centre for Accounting and
Assurance Research, UNSW Business School, UNSW Australia, Sydney, NSW 2052,
Australia.
E-mail addresses: [email protected] (D. Mayorga), [email protected].
au (K.T. Trotman).
Contents lists available at ScienceDirect
Accounting, Organizations and Society
j ournal homepage: www. el sevi er. com/ l ocat e/ aoshttp://dx.doi.org/10.1016/j.aos.2015.10.003
0361-3682/© 2015 Elsevier Ltd. All rights reserved.
Accounting, Organizations and Society xxx (2015) 1e13
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
reasonable person would not expect the information to be dis-
closed.
1
Despite the importance of the reasonable investor concept,
little empirical evidence exists regarding its effect on the judg-
ments of preparers, audit committees or auditors (for an exception
see Altiero, Kang, & Peecher, 2015 who examine perspective taking
on auditor judgments).
Research in psychology shows that while individuals have the
ability to take another person's perspective into account (Davis, 1983;
Epley, 2008; Epley & Caruso, 2009; Keysar & Barr, 2002), they may
face dif?culties in getting beyond their ownpoint of viewto consider
the facts fromanother's perspective (e.g., Epley&Caruso, 2009; Epley,
Keysar, Boven, &Gilovich, 2004). Additionally, psychological research
on the impact of motivated reasoning suggests that individuals face
dif?culties in evaluating information and making judgments impar-
tially when they have a stake in reaching a particular outcome
(Kunda, 1990). For instance, individuals judge evidence supporting
their preferred outcomes to be more important and to have stronger
implications than evidence con?icting with their preferred outcome
(e.g., Ditto & Lopez, 1992; Lord, Ross, & Lepper, 1979). Accounting
research ?nds that, given suf?cient ambiguity, accounting pro-
fessionals' judgments are vulnerable to motivated reasoning effects
(Hackenbrack & Nelson, 1996; Kadous, Kennedy, & Peecher, 2003;
Peecher, Piercey, Rich, & Tubbs, 2010) and that pre-existing prefer-
ences to reach a certain desired outcome indirectly in?uence pro-
fessionals' judgments byaffectingthemanner inwhichinformationis
evaluated (e.g., Wilks, 2002). As managers have clear preferences
regarding their ?nancial reporting choices (Bamber et al., 2010), we
contend that when managers do not consider a reasonable investor's
perspective they may take advantage of the uncertainty surrounding
a disclosure issue to arrive at a self-interested disclosure recom-
mendation as long as their disclosure outputs are justi?able.
Our paper reports the results of two experiments. In the ?rst
experiment, we manipulate whether managers are prompted to
consider the perspective of a reasonable investor (prompt versus no
prompt) and knowledge of the ?rm's prior disclosure policy
(known, that its past preference is biased towards no disclosure,
versus unknown) to examine the impact on disclosure judgments
for a new subjective disclosure matter. Experienced senior ?nance
managers, mainly company secretaries,
2
make a disclosure
recommendation on whether a probable negative change in the
company's earnings expectations should be disclosed. Our results
show that managers make disclosure recommendations that are
more supportive of disclosing a negative change in earnings' ex-
pectations when they are prompted to take a reasonable investor's
perspective compared to when they are not and this effect is
stronger when managers do not know the ?rm's prior disclosure
policy.
We conduct a second experiment to establish that our results
are robust to the way managers are prompted to consider the
perspective of a reasonable investor when making disclosure rec-
ommendations. We design the experiment to include an indirect
approach to stimulate managers' consideration of a reasonable
investor's perspective. This approach allows us to examine the ef-
fect of a reasonable investor prompt on managers' disclosure rec-
ommendations while reducing possible demand effects. In a 1 x 3
experiment, we replicate the reasonable investor prompt manip-
ulation used in the ?rst experiment (i.e., managers are prompted to
take the perspective of a reasonable investor or not) as well as add a
new prompt condition in which managers rate the likelihood that
the disclosure matter would in?uence a reasonable investor's in-
vestment decision prior to making their own disclosure recom-
mendation. We ?nd that managers in both prompt conditions are
more likely to recommend disclosure of a probable negative change
in their company's earnings expectations than managers in the no
prompt condition. Our additional analysis shows that managers
who are prompted to take the perspective of a reasonable investor
are more likely to consider reasons for and against disclosing a
probable negative change in their company's earnings expecta-
tions. This suggests that perspective taking may be an effective
mechanism to reduce unintentional biases in interpreting and
evaluating information.
2. Background and hypothesis development
2.1. Reasonable person concept and Australia's continuous
disclosure regime
‘Reasonable person’ is a legal construct. The term originates
from the English legal system enabling issues of ‘ought’ to be
resolved by reference to the objective fact of whether a reasonable
person would have done likewise (Uren, 2003). In law, ‘reasonable
person’, as a reference to a community standard, has been a
powerful metaphor for establishing negligence.
3
The concept of a
reasonable person has also been a signi?cant feature in the pro-
fessional accounting literature for many decades. For example, in
its Statement of Financial Accounting Concepts No. 2, the Finan-
cial Accounting Standards Board's states that “the omission or
misstatement of an item in a ?nancial report is material if, in the
light of surrounding circumstances, the magnitude of the item is
such that it is probable that the judgment of a reasonable person
relying upon the report would have been changed or in?uenced
by the inclusion or correction of the item” (FASB, 1980). The SEC
provides guidance that a matter is material “if there is a sub-
stantial likelihood that a reasonable person would consider it
important” (SEC, 1999). This formulation is reinforced by legal
decisions, such as that rendered by the US Supreme Court which
held that “an omitted fact is material if there is a substantial
likelihood that a reasonable shareholder would consider it
important in deciding how to vote”.
4
In more recent auditing and
accounting settings, the reasonable person/reasonable investor
standard has been applied in determining auditor independence
(AICPA, 1988; APESB, 2007), in the consideration of materiality in
planning and performing audits (IFAC, 2006; PCAOB, 2010), in the
preparation of management's discussion and analysis (CICA,
2009), in the disclosure of inside trading information (FCA,
2013), in the evaluation of ?nancial statement errors (Pozen,
1
As required by the Continuous Disclosure (CD) Requirements which consist of
Australian Securities Exchange Listing Rule 3.1 and 3.1A and Chapter 6 of the Cor-
porations Act.
2
In Australia, company secretaries are part of the executive management team.
One of their key responsibilities is to advise the board on the company's statutory
disclosure obligations. They are considered to be of?cers of the company, and
therefore, can be held personally liable and subject to civil penalties in the event
their company is found to have contravened the CD provisions of the Corporations
Act. In the US, company secretaries are referred to as corporate secretaries.
3
In Blyth v Birmingham Waterworks Co (1856) 11 Ex Ch 781. The court found
that the defendants could only have been negligent if they had failed to do what a
reasonable person would do in the circumstances. This case de?ned negligence as
“the omission to do something which a reasonable man, guided upon those con-
siderations which ordinarily regulate the conduct of human affairs, would do, or
doing something which a prudent and reasonable man would not do. The de-
fendants might have been liable for negligence, if, unintentionally, they omitted to
do that which a reasonable person would have done, or did that which a person
taking reasonable precautions would not have done.”
4
TSC Industries Inc v Northway Inc 426 US 438 (1976). Also, see Mitchell v Texas
Gulf Sulphur Co., 446 F2.D 90, at 99e100 (10th Circuit, 1971) and Escott et al. v.
BarChris Construction Corporation et al., 283 Fed. Supp. (District Ct. S.D. New York,
1968) p. 681.
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Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
2008) and in Australia's continuous disclosure regime (ASX,
2013).
5
Continuous disclosure is a central tenet of the Australian regula-
tory landscape for listed public companies. It is primarily based on a
combination of Australian Securities Exchange (ASX) requirements
and the legislative provisions of Australia's Corporation Act. Of in-
terest to this study is Australian Securities Exchange Listing Rule 3.1
(ASX LR3.1) which requires an entity to immediately disclose infor-
mation that a reasonable person would expect to have a material
effect on the price or value of the entity's securities (referred to as
“market sensitive information”). Information is market sensitive if it
would, or would be likely to, in?uence persons who commonly
invest in securities in deciding whether to acquire or dispose of the
securities. The ASX has acknowledged that determining whether
information is market sensitive can be dif?cult in practice as listed
entities are “effectively requiredtopredict howinvestors will react to
particular information when it is disclosed” (ASX, 2013, p. 10). Given
this dif?culty, the ASX suggests that managers may ?nd it helpful to
take the perspective of a reasonable investor when faced with
continuous disclosure decisions (ASX, 2013).
2.2. Directional goals and managers' disclosure judgments
Managers have economic incentives to disclose information
opportunistically (e.g., Aboody & Kasznik, 2000) including with-
holding bad news (e.g., Kothari, Shu, &Wysocki, 2009). For example,
managers have incentives related to stock valuation, career concerns
and external reputation, and these incentives can drive managers to
delay disclosure of bad news in the hope that the ?rm's performance
will improve before the next required information release, to allow
further study and interpretation of the information, or to package
the bad news with other disclosures (Graham, Harvey, & Rajgopal,
2005). In addition, managers have preferences to maintain pre-
dictability in earnings and ?nancial disclosures (Graham et al.,
2005). Managers are likely to use these preferences as a starting
point, or judgmental anchor, when assessing new disclosure infor-
mation and subsequently adjust away fromtheir anchor to take into
account the speci?cs of the new disclosure context.
Motivated reasoning research shows that directional goals bias
individuals' beliefs about the perceived likelihood of events (Klein
& Kunda, 1992; Kunda, 1990). Desirable events are perceived as
more likely to occur when individuals make a subjective interpre-
tation of the events occurring (Irwin, 1953; Irwin & Snodgrass,
1966; Marks, 1951). For example, individuals can interpret their
belief that an event has a 60 percent probability of happening to
mean that the event is either slightly likely, or somewhat likely, to
happen, depending on whether they want to view it as likely
(Kunda, 1990, p. 488). Individuals' interpretation of an event, in
turn, can affect their willingness to assume and bet that the event
will occur (Arrowood & Ross, 1966). Several studies in accounting
provide evidence that the decisionprocesses of managers, investors
and traders are susceptible to directional reasoning mechanisms
(e.g., Hales, 2007; Han & Tan, 2010; Seybert & Bloom?eld, 2009;
Tayler, 2010). Consistent with motivated reasoning theory, this
suggests that managers' directional goals may bias their judgments
about the likelihood of a negative change in earnings expectations
as long as their ?nal disclosure recommendations appear reason-
able and justi?able based on the available information.
Directional goals are also likely to bias managers' disclosure
judgments when the disclosure issue is ambiguous. Psychological
research indicates that ambiguous information allows for multiple
interpretations (e.g., Montgomery, 1989) and therefore makes it more
likely that directional goals will exert in?uence on individuals' judg-
ments (Schweitzer & Hsee, 2002). Even when individuals have goals
to process information objectively, they may be unable to do so as
their pre-existing directional preferences may foster more extensive
defensive processingof ambiguous information(Liberman&Chaiken,
1992). Consistent with this, Hales (2007) demonstrates that when
investors were only given explicit incentives to be accurate in their
earnings forecasts, their directional goals still biased their forecasts.
Consequently, we expect that managers’ directional goals to withhold
badnews will leadtoa self-serving“donot disclose” recommendation
as a starting point for a new ambiguous disclosure matter.
2.3. Effect of perspective taking on managers' disclosure judgments
Whenmanagers are facedwitha decisiononwhether information
needs todisclosed, theyshouldconsider whether the informationwill
in?uence a reasonable investor's investment decision(ASX, 2013). An
important question, however, is whether managers can effectively
predict how investors will react to particular information when it is
disclosed. The psychology literature has long recognized that in-
dividuals' social judgments tend to be egocentrically biased (e.g.,
Davis, 1983; Epley et al., 2004). One way for individuals to overcome
their egocentric biases and tailor their behaviors to others' expecta-
tions is through perspective taking (Batson, Early, & Salvarani, 1997;
Davis, 1983; Davis, Conklin, Smith, & Luce, 1996; Epley & Caruso,
2009).
6
Considering others' perspectives has been found to increase
the likelihood of helping another person in need (Batson, 1994),
reduce the use of stereotypes when forming impressions (Galinsky &
Moskowitz, 2000), increase negotiation effectiveness (Neale &
Bazerman, 1983) and diminish a variety of problematic egocentric
biases in judgment (Savitsky, Van Boven, Epley, & Wight, 2005;
Wade-Benzoni, Tenbrunsel, & Bazerman, 1996).
The anchoring and adjustment model of perspective taking
(Epley & Gilovich, 2004; Epley et al., 2004) predicts individuals
adopt others' perspectives by initially anchoring on their own more
readily accessible perspective and subsequently adjusting to ac-
count for differences between themselves and others until a plau-
sible estimate is reached (Epley & Caruso, 2009; Epley & Gilovich,
2006; Epley et al., 2004; Nickerson, 1999; Tversky & Kahneman,
1974). However, these adjustments tend to be insuf?cient (Epley
et al., 2004; Tversky & Kahneman, 1974), and, as a result, many
assessments of others’ perspectives remain egocentrically biased.
Psychology research suggests that factors facilitating careful
thought will decrease individuals' egocentric bias in perspective
taking (Epley et al., 2004). For example, Epley, Caruso, and Bazerman
(2006) demonstrate that when individuals are explicitly asked to
consider another's thoughts, they are more likely to adopt another's
perspective than when individuals are not explicitly asked. In an
auditingcontext, Altieroet al. (2015) ?ndthat auditors, whoengage in
investor-minded tasks prior to making materiality judgments, pro-
vide better quality judgments than auditors who do not.
5
In Australia, the Federal Court of Australia has considered expert witness tes-
timony in determining whether a reasonable person would have expected disclo-
sure. That is, if the information had been disclosed, would it have had a material
effect on the value of the company's share value? Experts used to provide expert
testimony have included experienced share portfolio managers, stockbrokers, an-
alysts, capital market academics and economists. For example, in Australian Secu-
rities & Investments Commission v Fortescue Metals Group Ltd [No 5] [2009] FCA 1586
(23 December 2009), the judge, J. Gilmour, considered the relevance of expert
opinion of statisticians, stockbrokers and analysts in determining contraventions of
CD provisions.
6
In this study, perspective taking refers to the ability to “intuit”, as accurately as
possible, another person's thoughts, feelings, attitudes, interests, or concerns in a
particular situation (Chartrand, 1999; Davis, 1983; Epley & Caruso, 2009; Epley,
Savitsky, & Gilovich, 2002).
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Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
In our study, we explicitly prompt managers to consider the
perspective of a reasonable investor. Taking this perspective should
increase managers' attention to a reasonable investor's disclosure
preferences. Managers should also give greater consideration to the
ways in which a reasonable investor might perceive the disclosure
issue differently. This consideration is likely to motivate managers
to adjust from their own personal disclosure preferences and thus
lead to less egocentric disclosure recommendations. For example,
as investors typically judge more corporate disclosure as better
than less (e.g., Hermalin & Weisbach, 2012), managers are more
likely to consider reasons supporting disclosure when they are
explicitly prompted to consider a reasonable investor's perspective.
In turn, these managers will make disclosure recommendations
which are more supportive of disclosing a negative change in
earnings expectations compared to managers who are not explic-
itly prompted. Our expectations are summarized below.
Hypothesis 1. Managers are more likely to recommend disclosure
of a negative change in earnings expectations when they are
prompted to take the perspective of a reasonable investor than
when they are not.
2.4. Firm's prior disclosure policy
Psychology research suggests that there are factors that inhibit
the anchoring and adjustment model of perspective taking (Epley
et al., 2004). Of particular relevance to our study is the effect of
the ?rm's prior disclosure policy which develops as a result of
institutional and market factors as well as ?rm speci?c factors
including ?rm traditions and internal politics (Gibbins et al., 1990;
Holland, 2005; Holland & Stoner, 1996), personal preferences
(Bamber et al., 2010; Brochet, Faurel, &McVay, 2011) and disclosure
preferences instituted by the board (Caskey, Nagar, & Petacchi,
2010; Richardson, Tuna, & Wysocki, 2003). To the extent that
managers take into account the ?rm's prior disclosure policy, it is
likely to in?uence their perspective taking processes.
2.5. Effect of ?rm's prior disclosure policy when there is a
reasonable investor prompt
Epley et al. (2004) suggest that individuals engage in anchoring
and adjustment only when it is clear that their views represent a
reasonable starting place. In situations where individuals' own
perspective is irrelevant, they state that quite different perspective
taking processes may be involved. For example, when managers
know their ?rm's prior disclosure policy is biased towards no
disclosure, they are more likely to anchor on their ?rm's prior
disclosure policy when assessing the perspective of a reasonable
investor. Further, managers are likely to insuf?ciently adjust from
this anchor point because knowledge of ?rm's preferred policy
yields an acceptable disclosure recommendation without too much
cognitive thought. In particular, psychological research indicates
that the adjustment process is effortful and individuals tend to
terminate the adjustment process once a plausible judgment is
made (Epley & Gilovich, 2006). This implies that knowledge of the
?rm's preference will diminish managers' willingness to exert extra
cognitive thought to seek a more objective disclosure judgment.
Consequently, we expect managers' consideration of a reasonable
investor's perspective will be less when they know the ?rm's prior
disclosure policy is biased towards no disclosure as their anchoring
and adjustment process will be in?uenced by knowledge of the
?rm's disclosure preferences. Thus, relative to when the ?rm's prior
disclosure policy is unknown, we expect that managers will be less
likely to recommend disclosure when they are prompted to take a
reasonable investor perspective and the ?rm's prior disclosure
policy is known. Our expectationis shownas the solid line inFig. 1 as
an upward sloping line fromthe reasonable investor prompt known
condition to the reasonable investor prompt unknown condition.
2.6. Effect of ?rm's prior disclosure policy when there is no
reasonable investor prompt
Motivated reasoning theory indicates that individuals arrive at
their preferred outcomes subject to their ability to construct
seemingly rational justi?cations for their choices and decisions
(Kunda, 1990) and that individuals engage in the minimum of
reasoning to reach their preferred outcome even if more bias would
still be viewed as reasonable (Boiney, Kennedy, & Nye, 1997).
Further, psychological research suggests that when individuals face
situations with greater uncertainty surrounding the appropriate
decision, they may ?nd it easier to justify a preferred outcome
(Hsee, 1995, 1996; Schweitzer & Hsee, 2002).
Uncertainty surrounding the appropriate disclosure recommen-
dation can be in?uenced by knowledge of the ?rm's prior disclosure
policy. When managers knowthat the board has expressed concerns
about management's prior history of disclosing information that is
dif?cult toquantify, there is more certaintyabout the ?rm's disclosure
preferences, and correspondingly less of a need for managers to
engage in a mentally costly evaluation of the evidence to arrive at a
justi?able disclosure recommendation, inthis case a “donot disclose”
recommendation. On the other hand, when managers do not know
the ?rm's prior disclosure policy, there is less certainty as to whether
the board will support or oppose disclosure for the new disclosure
issue andmanagers will needtodevote extra mental thought toarrive
at a defensible disclosure recommendation. Managers are therefore
likely to make a more thorough examination of the evidence, irre-
spective of its direction, to prepare themselves for a variety of re-
actions totheir recommendations. The motivatedreasoningliterature
indicates that deeper processing of both sides of an issue includes
automatic goal-driven processes that bias individuals toward reach-
ing and justifying preferred outcomes (Kunda, 1990; Peecher et al.,
2010). Managers' more thoughtful, but biased, information process-
ing is therefore likely to result ina “donot disclose” recommendation.
This discussion implies that managers who do not know the ?rm's
prior disclosure policy are likely to make stronger “do not disclose”
recommendations than managers who know that the ?rm's prior
disclosure policy is biased towards no disclosure. This would suggest
that the dotted line in Fig. 1 slopes downwards from left to right.
However, researchinaccountability(see Lerner andTetlock(1999)
for a review), predecisional distortion (e.g., Ricchiute, 2004; Wilks,
2002) and motivated reasoning (e.g., Cloyd & Spilker, 1999) demon-
strate that knowledge of a relevant audience's views can signi?cantly
affect accounting professionals' decision making. Although this
researchsuggests that knowledge of the ?rm's prior disclosure policy
will impact managers' disclosure recommendations, overall it is not
clear whether managers will be less or more likely to recommend
disclosure when they are not prompted to take the perspective of a
reasonable investor and know the ?rm's prior disclosure policy
compared to when they do not know. In light of these competing
predictions, no differences are predicted between the known and
unknownconditions whenthereis noprompt. ThedottedlineinFig. 1
illustrates the graphical representation of our expectation.
As depicted in Fig. 1, we predict an interaction between the
reasonable investor prompt and ?rm's prior disclosure policy such
that the difference in managers' disclosure recommendations is
greater whenthe ?rm's prior disclosure policyis unknownthanwhen
it is known. We formally state this interaction hypothesis below:
Hypothesis 2. The effect of a prompt to take the perspective of
reasonable investor on managers' disclosure recommendations is
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greater when the ?rm's prior disclosure policy is unknown than
when it is known.
3. Method-Experiment One
3.1. Participants
Sixty senior managers and directors who contribute to their
public companies' ?nancial information disclosure decision-
making processes participated in the experiment. The authors
personally recruited potential participants over an eight month
period by contacting professional associations, university advisory
and alumni networks and industry contacts as well as by directly
contacting top management of public ?rms. From these contacts,
the authors mailed 89 research packets. Sixty senior managers and
directors completed and returned the research materials, for a
response rate of 67 percent.
7
Participants were promised con?-
dentiality of information and an A$50 (approximately US$35 at the
time) gift voucher for participating in the study.
The participants comprised 40 company secretaries, nine CFOs/
?nancial controllers, ?ve directors, ?ve CEOs and one commercial/
investor relations manager.
8
Sixty-one percent of the participants
have signi?cant work experience (e.g., greater than 20 years) with a
?rm listed in the Australian Securities Exchange (ASX) top 200
listed companies by way of market capitalization. The other 39
percent of participants had a minimum of 10 years of signi?cant
work experience.
9
The participants had an average rating of 8.14
(median ¼ 8, range 2e10) on a 10-point scale ranging from 1 (‘not
at all familiar’) to 10 (‘very familiar’) in terms of their familiarity
with making CD decisions. In response to the question “How many
times have you been involved in making similar types of ASX
Listing Rule 3.1 and 3.1A decisions?”, seven percent of the partici-
pants reported more than a 100 times, 14 percent reported 50 to
100 times, eighteen percent reported 20 to 49 times, 18 percent
reported ten to 19 times, and 43 percent reported two to nine
times.
10
In sum, participants were highly experienced managers
and very experienced at this task.
3.2. Case materials
The case was adapted with signi?cant modi?cations from Tan
and Trotman (2010). At the beginning of the case, managers learn
the following:
In this study, you will be asked to assess a speci?c matter that has
recently come to the attention of management and provide to the
Board of Directors a recommendation based on whether you
believe [a reasonable investor would expect that] the information
should be disclosed.
11
The ‘speci?c matter’ deals with whether information regarding
a probable negative change in forecast revenue requires immediate
disclosure under Australia's CD regulation.
The case materials contain selected historical ?nancial results
for the company over a two-year period (revenue, operating pro?t,
EPS), and projections for the current year (forecast revenue, fore-
cast operating pro?t, forecast EPS and analysts' consensus EPS
forecast). This is followed by details of the disclosure matter which
involves a probable negative change in forecast revenue for a major
new contract with a government department for leasing of satel-
lites for high-bandwidth. The contract includes signi?cant penalty
clauses related to satellite downtime. The company previously
released a revenue forecast for the contract for the current year
Fig. 1. This ?gure illustrates the study's predictions of the joint effects of the reasonable investor prompt and ?rm's prior disclosure policy on managers' disclosure judgments.
Prompt ¼ participants are prompted to take the perspective of a reasonable investor. No Prompt ¼ participants are not prompted to take the perspective of a reasonable investor.
Known ¼ participants are told that the ?rm's prior disclosure policy is biased towards no disclosure. Unknown ¼ participants are not given information about the ?rm's prior
disclosure policy. Disclosure Judgment ¼ more or less likely to recommend disclosure of a probable negative change in the company's earnings expectations.
7
Prior to data collection, we decided to collect a minimum of ?fteen observations
per cell given the challenges in recruiting professional participants who had
experience in making continuous disclosure decisions for ASX listed ?rms. We
terminated data collection at the end of eight months as this study formed part of
one of the author's PhD dissertation with time deadlines.
8
These positions generally sit on the ?rm's Disclosure Committee (Kwak, Ro, &
Suk, 2012; Mayorga, 2013). Disclosure committees manage the process of making
?nancial information disclosure decisions. If the ?rm doesn't have a disclosure
committee, these managers may be involved in the disclosure process indirectly
through their role as an internal governance advisor to the CEO and board.
9
Once participants had returned the research materials, they emailed the re-
searchers stating that they had completed the case so that a gift certi?cate could be
sent in appreciation of them taking part in the research. Hence, the researchers
have the names of all the study's participants. To calculate their work experience
level, we accessed external sources (e.g., annual reports, LinkedIn). For 92% of the
sample, we are able to report actual experience levels. For the remaining 8%, we are
only able to report a minimum of 10 years work experience. For con?dentiality
reasons, we could not link names to individual research instruments.
10
Participants' current position, familiarity with making CD decisions and the
number of times they had been involved in making similar types of CD decisions
did not differ signi?cantly (p > 0.10) across the four experimental conditions.
Participants' current position did not interact signi?cantly with any of the inde-
pendent variables in the study.
11
The phrase in brackets was only given to the reasonable investor prompt
conditions.
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with no allowance for penalties. Management has received pre-
liminary evidence suggesting that downtime has exceeded the
permitted level and believes it is probable that some penalty costs
will be incurred but they are uncertain of the extent of these po-
tential penalty payments.
Participants are given informationwhich shows various revenue
and earnings per share projections after recognizing estimates of
penalties ranging from 100 percent to 33.3 percent of the potential
penalty and the estimated decrease in forecasted EPS for the
different levels of penalties. Depending on the assumption a
participant adopts with respect to potential penalties, the impact
on projected operating pro?t will range fromnil decrease (assumes
no penalty) to an eight percent decrease (assumes the maximum
amount of penalties). Thus, the case requires participants to exer-
cise signi?cant judgment in determining whether the matter is
quantitatively and/or qualitatively material. For example, recog-
nizing 33.3 percent of potential penalties is three percent of pro-
jected operating income and it moves the company's forecasted EPS
from above to below the analysts' consensus EPS and results in a
change in earnings trends from prior years. Recognition of one-
third of the penalties also affects ratios used to evaluate the com-
pany and is a change from the projected revenue disclosures made
earlier in the year. The participants need to consider both quanti-
tative and qualitative materiality.
Evidence items were facts drawn from the background infor-
mation about the client and details of the speci?c disclosure matter
which participants read prior to evaluating the evidence.
12
The case
consisted of ten evidence items supportive of disclosure and ten
items not supportive of disclosure.
3.3. Design
This experiment employed a 2 x 2 between-subjects factorial
design. The ?rst independent variable was Reasonable Investor
Prompt (Prompt versus No Prompt). Both conditions were instructed
to assume the role of company secretary, assess a potential
disclosure matter and provide to the board of directors a recom-
mendation on whether the information should be disclosed. Par-
ticipants assigned to the no prompt condition were asked to assess
a speci?c disclosure matter that has come to the attention of
management and provide a recommendation to the Board of Di-
rectors based on “whether you believe the information should be
disclosed”. Participants assigned to the prompt condition were
asked to “step into the shoes of a reasonable investor” and assess a
speci?c disclosure matter that has come to the attention of man-
agement and provide a recommendation to the Board of Directors
based on “whether you believe a reasonable investor would expect
that the information should be disclosed”. We chose the term ‘step
into the shoes of a reasonable investor’ based on the terminology
used in Pozen (2008). To heighten participants' awareness that
their disclosure judgments should be based on whether a reason-
able investor would expect disclosure, the case instructions
emphasized for the prompt condition that it is important to react to
the disclosure matter “as though you are providing a disclosure
recommendation based on what you believe a reasonable investor
would provide”.
The second independent variable was the Firm's Prior Disclosure
Policy (Known versus Unknown). Participants assigned to the known
condition read the following immediately before reviewing the
background information and evaluating evidence
13
:
At the last Board of Directors' meeting, the board of Germa Satellite
Limited expressed its concern that management has been overly
vigilant and conservative in disclosing information in situations
where it was dif?cult to quantify the magnitude of the event. All the
directors indicated that releasing speculative information may
potentially harm the ?rm's share price for no underlying economic
reasons.
The words “at the last Board of Directors' meeting” were
included in the ?rm's prior disclosure policy to ensure that the
information contained in the ?rm's prior disclosure policy
description is independent of the information on the new disclo-
sure matter. This is important as the study investigates whether a
prior disclosure policy in?uences how new disclosure decisions
are impacted.
To heighten their awareness of the board's concern (see Peecher,
1996; Wilks, 2002), participants are then asked to list three reasons
why a listed company would prefer to delay disclosure of infor-
mation where it is dif?cult to quantify the magnitude of the event
14
and to rank these reasons in order of their impact on managers'
disclosure judgments with the ?rst reason being the most in?u-
ential and the third being the least in?uential. Participants assigned
to the unknown conditions are not given the ?rm's prior disclosure
policy in their research packet.
15
3.4. Procedures
Individuals who had agreed to participate in the study were
randomly assigned to one of the four experimental conditions. Each
participant received by mail a numbered (for randomization and
control purposes) research packet. On the outside of the research
packet there were written instructions for the participant which
stated the importance of completing the task in one sitting and
completing the task individually and without discussion with col-
leagues. The instructions stated that the participant was one of a
small group of professionals involved in this important study and
that their participation was highly valued (Gibbins & Trotman,
2002). Participants then read the background information about
the company, the speci?c disclosure issue, the revenue projections
and the potential associated revenue write-downs.
Participants ?rst read and evaluated 20 evidence items related to
whether a revised earnings forecast was warranted under ASX's
Listing Requirements.
16
These items indicated reasons managers
may disclose or not disclose the speci?c disclosure issue. For
12
The evidence items were developed based on the following sources: Tan and
Trotman (2010), a review of Australian, US and UK case law on the application of
an obligation to disclose material information where that information is subject to
uncertainty, and a review of enforcement actions for breaches of CD requirements
undertaken by Australian Securities and Investment Commission.
13
Tetlock, Skitka, and Boettger (1989), Green, Visser, and Tetlock (2000) and
Wilks (2002) use the following words “insuf?ciently [overly]”, “strongly” and
“consistently” respectively to increase the participants awareness of their evalua-
tive audience's view in their experimental task. Consistent with this research, this
study uses an adverb, ‘overly’, to heighten participants' awareness of the ?rm's
prior disclosure policy.
14
All reasons provided by managers suggest that the ?rm's prior disclosure policy
manipulation induced them to believe that the ?rm's prior disclosure policy sup-
ports less disclosure.
15
In addition to the two independent variables, four random orderings of evi-
dence were constructed and fully crossed with the four conditions to reduce po-
tential order effects. This resulted in 16 research instruments. This order variable is
non-signi?cant in the ANOVA analyses (p > 0.10) and does not interact with any
other variables in the model. Thus, this variable is not further discussed.
16
ASX LR3.1 requires that once an entity is or becomes aware of any information
concerning it that a reasonable person would expect to have a material effect on the
price or value of the entity's securities, the entity must immediately tell ASX that
information unless speci?c conditions apply including that ‘a reasonable person
would not expect the information to be disclosed’.
D. Mayorga, K.T. Trotman / Accounting, Organizations and Society xxx (2015) 1e13 6
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
example, evidence items included “Last year a competitor reported
an earnings' downgrade due to penalty costs associated with
downtime” and“There is considerable uncertaintyas towhat will be
the total downtime for the year for this particular contract”. Evi-
dence items were evaluated individually using a 15-point bipolar
evidence evaluation scale with the À7 endpoint labeled “extremely
supportive of NOT disclosing immediately” to the 7 endpoint
labeled “extremely supportive of disclosing immediately” and the
center point labeled “neutral”. Participants then made disclosure
recommendations on a 15-point bipolar disclosure judgment scale
with the À7 endpoint labeled “clearly not required to be disclosed
immediately” and the 7 endpoint labeled “clearly required to be
disclosed immediately” and the center point labeled “completely
uncertain”. This disclosure recommendation was used for testing
Hypothesis 1 and Hypothesis 2. The labeling on both scales followed
Tan(1995), Wilks (2002) and Ricchiute (2004) withmodi?cations to
the wording to suit the task context. Following the disclosure
recommendation, participants rated the importance of each evi-
dence iteminreaching their disclosure recommendationusing a 10-
point response scale with the 1 endpoint labeled “not at all impor-
tant” and the 10 endpoint labeled “very important”. This measure
was used in additional analysis to further explain our results. Spe-
ci?cally, we examine whether their ratings of the importance of
eachevidence itemintheir ?nal disclosure judgment differ between
experimental conditions (Tables 3 and 4). Finally, participants
completed a questionnaire which included demographic questions
and manipulation check questions.
17
4. Results-Experiment One
4.1. Manipulation checks
To examine the effectiveness of the ?rm's prior disclosure policy
manipulation, managers were asked to indicate the board's concern
that management had been: (a) overly vigilant and conservative in
disclosing information that was dif?cult to quantify or (b) no
concern was mentioned. Twelve of the 60 participants failed to
provide correct answers to this manipulation check.
18
As the in-
ferences drawn from this study do not change when these 12
managers are excluded, they are included in the analysis.
As the securities exchange listing rules relate disclosure to what
a reasonable person would expect direct questions on whether a
reasonable investor perspective is taken are likely not to be very
different between conditions.
19
Thus we asked managers to indi-
cate whether they had a particular type of investor in mind when
completing the task. If they responded “yes”, we asked participants
to describe the type of investor. Sixty-eight percent stated that they
considered retail investors and thirty-two percent stated they
considered institutional investors in their disclosure decision
making process. A chi-square test comparing whether managers in
the prompt conditions were more likely to think of a particular type
of investor when completing the task than managers in the no
prompt conditions found a signi?cant effect (x
2
(1)
¼ 3.068,
p ¼ 0.040). Thus, on average, while managers believed they
considered disclosure recommendations from a reasonable
investor perspective, it was more likely that the managers in the
prompt conditions actually considered a reasonable investor's
perspective.
4.2. Hypothesis tests
Table 1 shows descriptive statistics across experimental condi-
tions for managers' disclosure judgments. The means for the prompt
unknown, prompt known, no prompt known, and no prompt un-
known conditions are À0.20, À1.80, À2.80 and À4.73 respectively.
The overall mean is À2.38. Fig. 2 presents the results graphically and
Table 2, Panel A reports results of an analysis of variance (ANOVA).
We ?nd a signi?cant main effect of the reasonable investor prompt
(F
1,56
¼ 8.459, p ¼ 0.005, two-tailed) and a marginally signi?cant
reasonable investor prompt by ?rm's prior disclosure policy inter-
action (F
1,56
¼ 3.449, p ¼ 0.069, two-tailed).
Table 2, Panel B reports our planned contrast tests. Consistent
with hypothesis 1 managers are more likely to recommend
disclosure of a negative change in earnings expectations when they
are prompted to take the perspective of a reasonable investor
(combined mean ¼ À1.00, Table 1) than when they are not
prompted (combined mean ¼ À3.77, Table 1) (t
(56)
¼ 2.908,
p ¼ 0.003, one-tailed, Table 2).
20
Hypothesis 2 predicts that the effect of the prompt to take the
Table 1
Experiment One: managers' disclosure judgments.
Means (std. dev.) [n] of the effects of reasonable investor prompt and
knowledge of the ?rm's prior disclosure policy on managers' disclosure
judgments
Reasonable
investor prompt
If participants know the ?rm's prior disclosure policy
Known Unknown Combined
Prompt À1.80 À0.20 À1.00
(3.82) (3.91) (3.89)
[15] [15] [30]
No Prompt À2.80 À4.73 À3.77
(4.23) (2.55) (3.57)
[15] [15] [30]
Combined À2.30 À2.47 À2.38
(3.99) (3.98) (3.68)
[30] [30] (60)
This table presents descriptive statistics for managers' continuous disclosure judg-
ments. Managers recommended on a 15-point scale whether disclosure of a revised
earnings forecast is required at this time (À7 ¼ clearly NOT REQUIRED TO BE DIS-
CLOSED immediately to 7 ¼ clearly REQUIRED TO BE DISCLOSED immediately,
center point labeled “completely uncertain”).
Prompt ¼ participants are prompted to take the perspective of a reasonable
investor.
No Prompt ¼ participants are not prompted to take the perspective of a reasonable
investor.
Known ¼ participants are told that the ?rm's prior disclosure policy is biased to-
wards no disclosure.
Unknown ¼ participants are not given information about the ?rm's prior disclosure
policy.
17
Feedback received from participants suggests that completion of the case ma-
terials ranged from 45 min to one hour.
18
Nine participants who failed this manipulation check were in the unknown
conditions for the ?rm's prior disclosure policy variable.
19
We asked participants to indicate the degree to which they made the recom-
mendation based upon their beliefs of a reasonable investor, on a 10-point scale
ranging from 1 (“not at all”) to 10 (“very much”). Participants in the no prompt
conditions had an average rating of 7.20 (s.d. 2.52) and participants in the prompt
conditions had an average rating of 7.27 (s.d. 1.64) with the differences not sig-
ni?cant (p > 0.10).
20
We also conducted an untabulated ANOVA for evidence evaluation as the
dependent variable. The means for the prompt unknown, prompt known, no
prompt known and no prompt unknown conditions are À1.05, À1.24, À1.73
and À2.41 respectively. Neither reasonable investor prompt (p ¼ 0.162), nor ?rm's
prior disclosure policy (p ¼ 0.709) or their interaction (p ¼ 0.505) are statistically
signi?cant. Using the same contrasts as above, we ?nd marginal support for the
proposition that managers evaluate evidence as more supportive of disclosure
when they are prompted to take a reasonable investor perspective than when they
are not (t
(56)
¼ 1.417, p ¼ 0.081, one-tailed). We do not ?nd support for the
reasonable investor prompt by ?rm's prior disclosure policy interaction
(t
(56)
¼ 0.672, p ¼ 0.253, one tailed). For the simple main effect tests, we ?nd
marginal support in the unknown condition (t
(56)
¼1.477, p ¼ 0.073, one-tailed) but
not in the known condition (p ¼ 0.300, one-tailed).
D. Mayorga, K.T. Trotman / Accounting, Organizations and Society xxx (2015) 1e13 7
Please cite this article in press as: Mayorga, D., &Trotman, K. T., The effects of a reasonable investor perspective and ?rm's prior disclosure policy
on managers' disclosure judgments, Accounting, Organizations and Society (2015),http://dx.doi.org/10.1016/j.aos.2015.10.003
perspective of a reasonable investor on managers' disclosure rec-
ommendations is greater when the ?rm's prior disclosure policy is
unknown than when it is known. The difference in managers'
disclosure recommendations between the two prompt conditions
is 4.53 (i.e., À4.73À(À0.20) when the ?rm's prior disclosure policy
is unknown and 1.00 (i.e., À2.80À(À1.80) when it is known. A
planned contrast test indicates that, as predicted by Hypothesis 2,
this difference is signi?cant (t
(56)
¼ 1.857, p ¼ 0.035, one-tailed,
Table 2 Panel B). Simple main effect tests (also shown in Table 2
Panel B) show that the prompt only has a signi?cant effect on
managers' disclosure judgments in the unknown condition
(t
(56)
¼3.370, p < 0.001, one-tailed) and not in the known condition
(t
(56)
¼ 0.743, p ¼ 0.230, one-tailed).
4.3. Additional analysis
Psychology research suggests that individual's pre-existing be-
liefs and preferred outcomes are “sticky” as a result of biased in-
formation processing (for a review of this research see Koonce &
Mercer, 2005). Individuals tend to be more critical of evidence
which discon?rms their preferred beliefs or outcomes (Ditto,
Munro, Apanovitch, Scepansky, & Lockhart, 2003; Edwards &
Table 2
Experiment One: ANOVA and planned contrasts for the effects of reasonable investor prompt and knowledge of the ?rm's prior disclosure policy on managers' disclosure
judgments.
PANEL A: Analysis of Variance
Source df Mean Square F-statistic Two-Sided p-value
Reasonable Investor Prompt 1 114.817 8.459 0.005
Firm's Prior Disclosure Policy 1 0.417 0.031 0.862
Reasonable Investor Prompt x Firm's Prior Disclosure Policy 1 46.817 3.449 0.069
Error 56 13.574
Reasonable Investor Prompt (prompt versus no prompt)
Firm's Prior Disclosure Policy (known to be biased towards no disclosure versus unknown)
PANEL B: Planned Contrasts
Hypothesized Contrasts df t One-Sided p -value
H
1
: Managers are more likely to recommend disclosure of a negative change in
earnings expectations when they are prompted to take the
perspective of a reasonable investor than when they are not.
56 2.908 0.003
H
2
: The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations is greater when the
?rm's prior disclosure policy is unknown than when it is known.
(m
PU
À m
NoPU
) > (m
PK
À m
NoPK
)
56 1.857 0.035
Simple Main Effects of Reasonable Investor Prompt
The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations when the ?rm's prior
disclosure policy is known.
56 0.743 0.230
The effect of a prompt to take the perspective of a reasonable investor on
managers' disclosure recommendations when the ?rm's prior
disclosure policy is unknown.
56 3.370