Limited Attention: Implications for Financial Reporting

• Published date: 01 December 2022
• Author: JINZHI LU
• Date: 01 December 2022
• DOI: http://doi.org/10.1111/1475-679X.12432

DOI: 10.1111/1475-679X.12432

Journal of Accounting Research

Vol. 60 No. 5 December 2022

Printed in U.S.A.

Limited Attention: Implications for

Financial Reporting

JINZHI LU ∗

Received 4 April 2020; accepted 25 March 2022

ABSTRACT

I develop a theory to study the consequences of providing more detailed

information to rationally inattentive investors. I first consider a simple

data-provision problem and show that adding more data or detail in fi-

nancial statements can make it more difficult for investors to extract

information. Consequently, investors who have limited information-

processing capacity may prefer less detailed information. I also show that

when investors’ decisions are complements, providing details in addition

to a summary may reduce investors’ welfare. More specifically, because of

∗Department of Accountancy, City University of Hong Kong

Accepted by Luzi Hail. This paper is based on my dissertation. I am grateful to the members

of my dissertation committee for their guidance and support: Haresh Sapra (chair), Philip

Berger, Jonathan Bonham, and Pingyang Gao. Special thanks to an anonymous referee and

an anonymous associate editor for their insightful comments and detailed guidance. I also

appreciate helpful comments from Cyrus Aghamolla, John Barrios, Jeremy Bertomeu, Agnes

Cheng, Aysa Dordzhieva, Vivian Fang, Frank Gigler,Joao Granja, Zhaoyang Gu, Ilan Guttman,

Jakob Infuehr,Eunhee Kim, Jeong Bon Kim, Christian Laux, Volker Laux, Christian Leuz, Jing

Li, Miao Liu, Yao Lu, Charles Mcclure, Xiaojing Meng, Michael Minnis, James Ohlson, Joshua

Ronen, Stephen Ryan, Douglas Skinner, Abbie Smith, WenfengWang, Anastasia Zakolyukina,

Guochang Zhang, Ruohuo Zheng, and workshop participants at the University of Chicago,

New York University,University of Minnesota, University of Texas at Austin, University of Hong

Kong, Hong Kong Polytechnic University, City University of Hong Kong, and Chinese Univer-

sity of Hong Kong. I gratefully acknowledge financial support from the University of Chicago

Booth School of Business. The work described in this paper was partially supported by a grant

from City University of Hong Kong (Project No. 7200644). I am grateful to my wife Ruofan

Chen for her encouragement and support. All errors are my own. An online appendix to this

paper can be downloaded at http://research.chicagobooth.edu/arc/journal-of-accounting-

research/online-supplements.

1991

© 2022 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1992 j. lu

increased disclosure of details, a coordination failure could occur in in-

vestors’ attention-allocation decisions. By showing that adding more detail

in financial statements can lead to an information overload problem for in-

vestors, this study yields valuable insights for accounting standard setters.

JEL codes: G14, M40, M41

Keywords: information overload; rational inattention

1. Introduction

Financial statements usually present accounting information in summa-

rized form, in which many details are suppressed. Should more detail or

data be provided to users of financial statements? This question is relevant

for accounting standard setting. For example, the Financial Accounting

Standards Board (FASB) is considering “improving the decision-usefulness

of the income statement through the disaggregation of performance in-

formation,” targeting lines that represent the cost of revenue and selling,

general, and administrative (SG&A) expenses.

This study develops a theory that highlights a novel cost of provid-

ing more data: Doing so could cause an information overload problem

when investors have limited attention. According to Blackwell’s Theorem

(Blackwell [1951]), providing more data in accounting reports should al-

ways make individual users better off in the absence of frictions. In particu-

lar, adding more data allows users to become more informed if they choose

to exploit that data, and they can ignore the additional data in the worst-

case scenario. Studies in the accounting literature have developed models

that show the negative consequences of disclosing more data (e.g., Dye and

Sridhar [2004], Kanodia, Singh, and Spero [2005], Gao and Liang [2013],

Gigler et al. [2014], and Liang and Zhang [2019]). In contrast to previ-

ous studies, this study provides a novel explanation for why providing more

data can backfire. On the one hand, adding data increases the maximum

amount of information that users can extract from financial statements.

On the other hand, adding more data makes it more difficult for users to

process information: Users have more data to sift through to obtain useful

information. In other words, users do not know which part of the data to

ignore before processing. Consequently, given investors’ limited attention,

more data can conceivably result in less information being extracted.

To formalize the above intuition, I follow Sims [2003] and model limited

attention by assuming that the amount of information that investors can ex-

tract from financial statements is bounded by their information-processing

capacity.1In the model, investors optimally allocate their capacity to ana-

lyze the various components in financial statements. One can think of a

component as, say, a summary measure of financial performance, such as

1In Sims [2003], the amount of information is captured by the reduction in mutual entropy.

See subsection 2.1 for details.

limited attention 1993

net income, a table that provides more granular detail about financial per-

formance, or a footnote that discloses supplemental information. By de-

ploying more capacity to a component, a user interprets the information in

that component with less error and hence acquires better information or,

equivalently, has less uncertainty regarding that component.

I consider a simple data-provision problem in which an investor with lim-

ited information-processing capacity analyzes a firm’s financial report to

make an investment decision. To capture the cost and benefit of adding

more data, I consider two reporting regimes: a summary regime in which

the firm discloses a summary statistic about its fundamentals and a detailed

regime in which the firm discloses two components of the fundamentals

separately.2The two components jointly produce more precise information

about the firm’s fundamentals than the summary. However, the investor

must divide her capacity to process each component, which implies that in-

formation processing is less efficient in the detailed regime. In particular,

the less processing capacity the investor has, the more severe the drawback

of dividing her capacity to process the components. I show that a critical

threshold exists such that the investor prefers the summary regime if and

only if her capacity is below this threshold.

Having studied the data-provision problem, I extend the model and con-

sider a setting in which investors not only care about fundamentals but also

need to coordinate their decisions (i.e., investors’ decisions are comple-

ments). Complementarity is an important feature of many environments

in practice, and the accounting literature has highlighted the importance

of information disclosure in such environments.3Introducing complemen-

tarity adds a layer to the benefit and cost of adding more data. Specifically,

when investors divide their capacity to process the details, each detail is pro-

cessed less thoroughly compared to the case in which they deploy all their

capacity to the summary. Therefore, investors achieve less synergy among

their investment decisions if they focus on details rather than the summary.

Consequently, complementarity exacerbates the information overload

problem and shifts investors’ preference toward the less detailed regime.

Finally, still assuming complementarity, I consider a third reporting

regime in which investors can flexibly choose between summary and de-

tails. For example, a firm can disclose standard accounting numbers in its

financial statement while referencing a note disclosure providing more de-

tail for interested users. This allows investors to choose how much detail

they want to delve into or to choose their preferred regime in the context

2For simplicity, I sometimes use “summary” to refer to the summary regime and “details” to

refer to the detailed regime.

3Examples of complementarity include initial public offerings (IPOs; Angeletos, Loren-

zoni, and Pavan [2007]), bank runs (Diamond and Dybvig [1983]), and lending (Hertzberg,

Liberti, and Paravisini [2011]). See Arya and Mittendorf [2016], Chen, Huang, and Zhang

[2014], Gao [2008], and Liang and Zhang [2019] for how financial reporting can affect stock

price efficiency, investment efficiency,and the likelihood of bank runs in such environments.