Connecting the Dots: Helping Investors Use Risk Disclosures When Evaluating Financial Statements

Abstract

The SEC and other policy makers continually seek to improve the decision-usefulness of firm risk factor disclosures. This study tests the impact of two related potential improvements on investor judgments. First, we test the SEC’s recent requirement of a two-page summary of risk factor disclosures, which was focused on increasing readability and reducing lengthy and boilerplate risk factor disclosures. Second, we propose and test hyperlinking risk factor disclosures to related financial statement line items. This proposal is based on theories from accounting and psychology that indicate such a change will facilitate greater causal coherence when evaluating financial statements. We test both potential improvements in an experiment with retail investors, and we find no evidence that the SEC s recent requirement impacts investor judgments. However, results show that hyperlinking significantly affects investor judgments. These findings question the effectiveness of the SEC s recent requirement and provide a new potential improvement for policy makers to consider.