| The Securities and Exchange Commission(SEC)published Rule 421(d)in 1998,and in it,mandated that listed companies must write certain sections of their prospectuses according to the "Plain English" rule,in order to help investors better understand the information contained therein,and to encourage better channels of communication and cooperation between investors and the corporate side.But even though ever since 421(d)has been enacted companies have indeed been compelled to abide by it when writing their prospectuses,there actually has not been much in the way of empirical research to test some of the fundamental assumptions underlying it,i.e.the belief that more readable disclosures will provide the greatest amount of help to the "least-sophisticated”investors.With the support of the SEC and the US federal government,the disclosure environment in the US has gradually shaped up to be dominated by the "Plain English" movement;likewise,the Chinese Securities Regulatory Commission(CSRC)has followed in these footsteps,and begun to incorporate into revisions of securities law and disclosures language requiring "plain writing" in such financial disclosures as prospectuses and annual reports.With an eye toward this legislative trend,this dissertation asks the central research question:do plainly-written financial disclosures really help the "least-sophisticated" investors the most?This dissertation regards retail investors as the subject of its research and utilises both experimental research methods and a theoretical framework based heavily on cognitive psychology theories,in order to explore the relationship between financial disclosure and investor judgment/decision-making.Specifically,this dissertation focuses on the following three aspects:(1)the way that readability and tone variations in financial disclosures individually influence invest judgment;(2)the interactive effect between readability and tone;and(3)the way that differences in investor financial literacy influences the significance of the aforementioned relationships.To explore the aforementioned questions,I employ classical experimental research methods:namely,I run two between-subjects factorial studies,and set as the dependent variable the investors’ judgment of future firm performance(in both),and set as independent variables the readability and tone of financial disclosures(only readability in the first and both in the second).I use real earnings releases from actual listed companies as a blueprint and,according to the needs of my experimental conditions,write multiple versions of earnings releases for a fictionalized company that satisfies the needs of my experimental conditions.Then,I ask participants to assume the role of a retail investor,to gain a better understanding of a company through readings its basic background and recent financial summary,and also to read a randomly assigned version of an earnings release;finally,I ask participants to use all information available to them about the company to make certain judgments about it,mostly with regards to its performance in future quarters.The first study takes a close look at the relationship between readability and investor judgment,further refining the theoretical framework by adding financial literacy as a variable,and thoroughly analyzing the cognitive pathways employed by investors when arriving at their ultimate judgments.Past research shows that high readability in financial disclosures has a "magnifying" effect on investor judgments,leading to them to make more positive judgments when faced with good news and more negative judgments when faced with bad news;past research finds that the readability effect is directional.This study,however,is not necessarily interested in the directionality or the magnitude of the change wrought by readability variation,and chooses instead to focus on whether high readability actually manages to increase accuracy in investor judgments.As results show,they do-to a certain extent:highly readable disclosures lead highly financially literate investors to make more accurate judgments,but this effect disappears when it comes to less financially literate investors.In other words,financial literacy is also a key factor that influences investor judgment,because it serves as a sort of shorthand for the investors’ fundamental ability to process financial information.When the investor is financially literate enough to handle complicated financial information that presents a heavy cognitive load,their judgments are shaped both by their understanding of the financial information and the cognitive fluency(i.e.subjective sense of ease borne out of higher readability);when the investor is not so financially literate,actual understanding of the financial information does not even come into the equation,and investor judgment is shaped almost solely by processing fluency.This implies significant things about past readability research:the effects that we can observe may be decomposed into starkly distinct effects for investors of differing levels of financial literacy.This study also provides empirical support for the aforementioned assumption in SEC’s Rule 421(d),and finds that even though disclosure readability and investor financial literacy do interact to influence judgment,the boost that highly readable disclosures provides for less financially literate investors is well-nigh negligible.In other words,even though increasing the readability of disclosures helps retail investors on average,the ones who enjoy the bulk of the boon are actually more financially literate investors(i.e.the ones who actually read these disclosures and try to make objective judgments about whether a company is over-or under-valued),not the less financially literate investors(i.e.the ones who are more likely to invest based on personal preference,media buzz,etc.).Unfortunately,these less financially literate investors are the same ones who would be willing to rely more on highly readable disclosures,despite the fact that the boost in readability has actually not done much to boost their understanding of the financial information contained therein.The second study focuses on three variables-readability,tone,and investor financial literacy-and their relationships directly with investor judgment and also with other.I set two experimental conditions,a good news condition and a bad news condition,and an identical 2 x 2 x 2 between-subjects study in each condition.Results show that,since positive tone and good news both impel investors to make judgments in the same direction(i.e.positively),the simultaneous appearance of positive tone and good news would therefore lead investors to make more positive judgments,and the role of tone in this case is a supplementary and supportive one:positive tone can help management to more efficiently and effectively convey information about the company to the investors.When it comes less financially literate investors,whether they can actually understand the financial information is a question that is still up in the air;low readability increases the cognitive cost of understanding the disclosure,and in the absence of actual understanding,the framing effect of positive tone tends to nominate investor judgment.More financially literate investors,on the other hand,would not be facing mere comprehension as an issue,and would also not find their comprehension of the financial information severely influenced by variations in disclosure readability;thus,the readability effect and the framing effect are both readily apparent when it comes to more financially literate investors facing good news,though the former is not necessarily influenced by changes in tone while the latter is not necessarily influenced by changes in readability.Positive tone and bad news,however,do not such good bedfellows make:they impel investors to make judgments in opposite directions,and the simultaneous appearance of positive tone and bad news would mean that the role of tone is a confused and confusing one:generally speaking,it would mean that management has deliberately chosen to use an unjustifiably positive tone in order to neutralise or dilute the impact that bad news would have on investor judgments.When it comes to less financially literate investors,the higher cognitive cost of low-readability disclosures mean that they are working from a place where they would not actually understand all the financial information;thus,they would be more likely to be misled by the framing effect of positive tone.More financially literate investors,on the other hand,would not fall into such a trap;on the contrary,they would not only be attuned to the inconsistency between firm performance and disclosure ton,and also likely intuit management motivation in causing this inconsistency,and ultimately respond to this attempt to deceive in a punitive fashion by making significantly lower judgments of future firm performance.The topic studied in this dissertation is new,and not quite in the mainstream just yet.Using retail investors as the subject of study and experimental methods as the means,this dissertation strove to investigate how two important characteristics of textual information in financial disclosures(readability and tone)influence investor judgments.The conclusions reached in this dissertation are innovative in the following two ways:1.The dissertation’s findings further refine the theoretical framework.Existing research finds that readability has a "magnifying" effect on investor judgments,i.e.when readability is high,investors make more positive(negative)judgments when faced with good(bad)news;existing research also finds that positive tone has a framing effect that would likewise impel investors to make more positive judgments.By factoring in financial literacy as an additional variable,this dissertation takes a closer look at the aforementioned two effects,and finds that the results commonly observed in existing research do not manifest uniformly in investors of all financial literacy.This dissertation further develops mediation pathways based on heuristics and the dual processing pathways models,in order to take a closer look at how understanding and processing fluency shape the investors’ cognitive pathways.2.The dissertation’s findings test fundamental assumptions of the "Plain English"/"plain writing" doctrine.The proliferation of the "Plain English" movement in the US has led to the SEC directly incorporating it into Rule 421(d)in 1998,mandating that listed companies abide by its rules when composing prospectuses.One of the fundamental assumptions underlying this move is the belief that plainly written financial disclosures can reduce the cognitive load(i.e.the cognitive cost)of the investors when they read it,and SEC further believes that this reduction will help "least-sophisticated" investors the most.In actuality,however,there has not been much in the way of empirically testing its fundamental assumptions since Rule 421(d)has been enacted.This dissertation thus strives to fill that gap,by providing an assessment of whether SEC has truly achieved what it set out to do. |
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