When US-based companies prepare financial reports according to generally accepted accounting principles, they usually present the information in a summarized form. Some authorities are considering requirements that would expand the scope of these reports, under the theory that presenting more information would improve transparency. But investors have limited attention, and too much detail can overload them—to the point that they may not process it efficiently, according to Chicago Booth PhD candidate Jinzhi Lu.
Using a model of reporting developed by MIT’s George-Marios Angeletos and Northwestern’s Alessandro Pavan as a base, Lu built a model in which investors are rational but subject to limited information-processing capacity, or limited attention, which could spur them to favor summarized information. In this case, giving them a choice of digging deeper—by presenting detailed information along with a summary—might seem to be a good alternative.
But even when details are presented as a sideline to a summary—for example, as the ancillary information given in notes to financial statements—the quality of investors’ decisions may not improve, Lu finds. His model suggests that when investors are presented with both options, they choose to process details even when doing so ends up being costly and producing worse outcomes. This tends to occur in situations where investors are influenced by the decisions of others, such as in stock market trades, initial public offerings, or bank creditor runs.
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Haresh Sapra Says Disclosure Has a DownsideWith organizations such as the Financial Accounting Standards Board pondering the level of detail that should be reflected in financial statements, these results have implications for accounting standards setting. In a push for more transparency, as Lu notes, FASB is considering whether to require more-focused reporting about certain activities. For example, the line item “selling, general, and administration expense” could be presented in a detailed way as “payroll, supplies, utility costs, depreciation, and other categories.”
While a summary of a financial statement may seem inadequate, Lu’s model demonstrates that attaching details to a summary can hurt the quality of investors’ decisions. Sometimes, less is more.
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