Investigating the Reaction of Investigating the Reaction of Relatively Unsophisticated InvestorsRelatively Unsophisticated Investors

To Audit Assurance onTo Audit Assurance onFirm-Released News AnnouncementsFirm-Released News Announcements

J. E. Hunton – Bentley CollegeJ. E. Hunton – Bentley College

J. L. Reck – University of South FloridaJ. L. Reck – University of South Florida

R. E. Pinsker – Old Dominion UniversityR. E. Pinsker – Old Dominion University

MotivationMotivation Individual investors, an understudied group,

are gaining sufficient numbers to ‘move’ the market.

Information technology allows for ubiquitous access to news announcements.

It is important to investigate the perceived value of independent assurance to relatively unsophisticated investors.

BackgroundBackground Investors use information to help them determine

the value of a firm (Watts and Zimmerman 1986; AICPA 1996; Beaver 1998).

Incomplete information, hampers investors’ ability to arrive at accurate valuations.

Incomplete information increases investors’ perceptions of information risk (Masters 1989).

BackgroundBackground

As Miller (2002, p 71) succinctly states: Incomplete information fosters [investor]

uncertainty. Uncertainty creates risk. Risk motivates investors to demand a higher

rate of return. Demand [for a higher rate of return] results in

a higher cost of capital and lower security [stock] prices.

BackgroundBackground Incomplete information has been defined in terms

of information asymmetry and information quality (Marston 1996; Beaver 1998; Miller 2002).

Of particular interest to the current study is the quality of information. at least one characteristic of quality information is

reliability (FASB 1980).

Information that is unreliable increases investor uncertainty, thus triggering the sequence of events identified by Miller (2002).

BackgroundBackground

By providing reliable information, firms can reduce investor uncertainty, decrease risk and increase stock prices (King et al. 1990; Olsen 1997; Kennedy et al. 1998).

Assessing reliability may be an especially difficult task for retail investors who are generally viewed as less sophisticated than institutional investors (Olsen 1997; Beaver 1998).

Prior ResearchPrior Research

A large body of research supports the value of the assurance function in improving the quality of information (“information hypothesis”) (e.g., Fama and Laffer, 1971; Wallace 1980, 1987)

Research studies since the 1980’s continue to support the information hypothesis, for instance →→

Prior ResearchPrior Research

An experiment by Pany and Smith (1982) found an association between auditor assurance and perceived information reliability.

A more recent study (Hodge 2001) found a moderately strong, positive correlation between reliability of information and the perceived earnings potential of a firm.

Prior ResearchPrior Research Prior research indicates a positive association

between audit functions and market value.

However, all of the prior research has focused on relatively sophisticated user groups.

Hence, there remains a question as to whether unsophisticated investors will have sufficient knowledge of auditors/audit services to allow for a positive association between audit functions and market value.

H1: Stock prices will be greater when management-provided information is accompanied by independent auditor assurance, as compared to no assurance.

There is no indication that unsophisticated investors would consider the presence of audit assurance to be a negative factor, but the investor may not value audit assurance enough to significantly adjust market prices.

Research Hypotheses → H1Research Hypotheses → H1

H2: The stock price increase related to audit assurance will be greater for a series of positive information releases, as compared to negative information releases.

Research Hypotheses → H2Research Hypotheses → H2

H3: Stock price variance will be smaller when the information is accompanied with independent auditor assurance, as compared to no assurance.

Research Hypotheses → H3Research Hypotheses → H3

Experimental DesignExperimental Design The experiment employed a 3 (direction of news:

positive, mixed or negative) by 2 (assurance: absent or present) between-subjects design.

The entire experiment was computerized via Visual Basic programming.

The program randomized participants into treatment conditions

The order of dependent variable measures, manipulation check questions and post-experiment psychological debriefing items were randomized.

Research ProcedureResearch Procedure

WelcomeScreen

TrainingScreens

CompanyBackground

News Announcement 1-10(++ : without Assurance)

News Announcement 1-10(-- : without Assurance

News Announcement 1-10(+- : without Assurance

News Announcement 1-10(++ : with Assurance)

News Announcement 1-10(-- : with Assurance

News Announcement 1-10(+/- : with Assurance

ManipulationChecks

Post-ExperimentQuestions

DemographicItems

Sample Computer ScreensSample Computer Screens

Sample Computer ScreensSample Computer Screens

Sample Computer ScreensSample Computer Screens

Usable Sample SizeUsable Sample Size

Direction of News

Assurance Total by Direction

Absent Present

Positive 30 32 62

Mixed 28 29 57

Negative 28 32 60

Total by Assurance

86 93 179

Demographic ResultsDemographic ResultsAge Brackets:

18-22 923-29 14330-39 27

Gender:Female 120Male 59

College Level:Seniors 18Masters 157Ph.D.s 4

LiberalLiberalArtsArtsMajorsMajors

Overall Means (S.D.)Overall Means (S.D.)

Direction of News

Assurance Total by Direction

Absent Present

Positive 58.41(1.77)

63.27(1.33)

60.92(2.90)

Mixed 50.52(0.53)

53.74(0.47)

52.16(1.75)

Negative 43.63(1.49)

46.80(0.83)

45.32(1.97)

Total by Assurance

51.03(6.27)

54.63(6.96)

52.90(6.87)

Source Sum of Squares

d.f. Mean Square

F-ratio p-value

Prior Investing Experience

0.6 1 0.6 0.4 .533

Risk of Investing in Universal

10.0 1 10.0 7.0 .009

Risk Propensity 0.1 1 0.1 0.1 .808

Enron-AA Impact 0.7 1 0.7 0.5 .476

Direction of News 5621 2 2811 1978 .001

Assurance 621 1 621 437 .001

Interaction 30 2 15 10 .001

Error Term 240 169 1.4

ANCOVA Model of 10ANCOVA Model of 10thth Stock Price Valuation Stock Price Valuation

Mean Share Prices Across Treatment Conditions as Each Announcment (Ann) was Presented

40.00

45.00

50.00

55.00

60.00

65.00

Ann_1 Ann_2 Ann_3 Ann_4 Ann_5 Ann_6 Ann_7 Ann_8 Ann_9 Ann_10

Pos_wo_Assurance Pos_w_Assurance Neg_wo_Assurance

Neg_w_Assurance Mix_wo_Assurance Mix_w_Assurance

H1 - Confirmed

Mean Share Prices Across Treatment Conditions as Each Announcment (Ann) was Presented

40.00

45.00

50.00

55.00

60.00

65.00

Ann_1 Ann_2 Ann_3 Ann_4 Ann_5 Ann_6 Ann_7 Ann_8 Ann_9 Ann_10

Pos_wo_Assurance Pos_w_Assurance Neg_wo_Assurance

Neg_w_Assurance Mix_wo_Assurance Mix_w_Assurance

H2 - Confirmed

Third Hypothesis (H3)Third Hypothesis (H3) Variances will be greater in all ‘direction of news’

conditions (++, --. +-) with assurance, as compared to without assurance.

H3 was only supported in the negative news (--) condition.

The mixed results associated with H3 were similar to prior behavioral studies that have had difficulty finding consistent results using variance as a measure of risk/uncertainty (Hodder et al. 2001).

SummarySummary Audit assurance can significantly increase the

value individual investors assign to stocks. The results held regardless of whether the

assurance was provided on a series of positive, negative or mixed sign disclosures.

The increase in stock price related to assurance was greatest when the firm released a series of positive information disclosures.

SummarySummary Stock price variance was consistently and

significantly smaller when audit assurance was provided on negative news disclosures.

The variances surrounding no assurance positive disclosures were larger than the variances surrounding the no assurance negative disclosures.

Hence, it appears the positive information provided by the firm was deemed less reliable than negative information

LimitationsLimitations

Usual external validity concerns related to experiments

Arbitrary choices made for the positive/negative news announcements

Length of the information series Participant pool Cost/benefit considerations

Future ResearchFuture Research Information overload concerns induced by

continuous reporting/assurance Why risk (variance) was reduced more in the

negative, as compared to positive, news condition.

Impact of other credible assurance providers on perceptions of reliability

Impact of having management certify the ‘truthfulness’ of disclosures on perceptions of reliability.