Do graphs of pro forma earnings influence investor judgment? In most cases they do and, according to a trio of investigators at Iowa State University (ISU), that means IROs will increasingly face ethical choices about the sorts of online financial analysis tools they make available to investors.
The research team presented a simulated IR website containing graphical interactive data views (IDVs) to both professional and non-professional investors. Pro forma graphs had no effect on the pros’ current year earnings judgments.
The non-pros’ judgments, however, were consistently higher when exposed to graphs containing pro forma as opposed to GAAP-only earnings information. Curiously, both professional and non-professional investors’ evaluations of potential earnings were higher when graphical IDVs contained pro forma earnings information. ‘The effects occur regardless of whether GAAP reconciliation information is available,’ notes study co-author William Dilla, associate professor of accounting at ISU.
While the SEC mandates reconciliation, it has yet to specify either the placement or the format of the reconciliation for pro forma graphs. For example, a website may display a pro forma graph and require investors to navigate to a separate page to view the reconciliation.
The increasing use of IDVs in IR websites (spurred by the mandate to furnish financial disclosures in XBRL) further muddies the water. IDVs allow users to generate customised displays of selected information, which may include displays of non-GAAP information with no reconciliation.
‘It appears technologies intended to simplify investors’ analysis of financial data may have the unintended consequence of leading to biased financial judgments,’ adds study co-author Diane Janvrin, associate professor of accounting at ISU.
‘The SEC can’t oversee what data investors generate on their own. It is largely up to companies themselves to control how interactive their data views will be. Some companies, such as Microsoft, make a point of ensuring reconciled information is in close proximity to the graph. Others, such as BP, do not.’
Visual priming helps investors notice and understand disclosure information better than plain text. But some types of visual priming – the enhanced awareness of an object as a result of prior exposure to displays associated with it – work better than others.
Researchers at the University of Connecticut – Stamford used an experiment to manipulate visual displays of disclosure information on a web page. They found that a pull-down menu featuring different categories, such as MD&A or ‘material change reports’, combined with text reading ‘Please carefully review the disclosure information’ was more likely to encourage investors to actually review the information than did a yellow Caution icon beside the headline ‘Disclosure information’.
‘Seeing a warning sign does little to help investors attend to and process disclosure information,’ says study co-author Alex Wang, associate professor at the Department of Communication Sciences. ‘In this case, the addition of the adverb ‘carefully’ in the text integrated with the active selection of categories was most effective.’