Why Do Individual Investors Disregard Accounting Information? The Roles of Information Awareness and Acquisition Costs

• Author: ELIZABETH BLANKESPOOR,ED DEHAAN,JOHN WERTZ,CHRISTINA ZHU
• DOI: http://doi.org/10.1111/1475-679X.12248
• Published date: 01 March 2019
• Date: 01 March 2019

DOI: 10.1111/1475-679X.12248

Journal of Accounting Research

Vol. 57 No. 1 March 2019

Printed in U.S.A.

Why Do Individual Investors

Disregard Accounting Information?

The Roles of Information

Awareness and Acquisition Costs

ELIZABETH BLANKESPOOR,

∗ED DEHAAN,

∗JOHN WERTZ,

∗

AND CHRISTINA ZHU

†

Received 25 October 2017; accepted 29 July 2018

ABSTRACT

We investigate the frictions that impede individual investors’ use of account-

ing information and, in particular, their costs of monitoring and acquiring

accounting disclosures. We do so using an archival setting in which indi-

viduals are presented with automated media articles that report both cur-

rent earnings news and past stock returns. Although these investors have

earnings information readily available, we find no evidence that their trades

∗Foster School of Business, University of Washington; †The Wharton School, University of

Pennsylvania.

Accepted by Douglas Skinner. We have benefited from discussions with Frank Hodge,

Charles Lee, Greg Miller, Rosh Sinha, Phil Stocken, Bill Tayler, Dan Taylor, Brady Twedt,

Hal White, an anonymous referee, and workshop participants at 2018 FARS Editors’ Picks

Plenary Session, BYU, University of Arizona, Cornell University, Georgia State University,

INSEAD, 2017 Minnesota Empirical Accounting Conference, Northwestern University, 2017

Penn State Accounting Conference, University of Rotterdam, Southern Methodist University,

2017 Tilburg Spring Camp, University of Virginia (Darden), University of Florida, Univer-

sity of Toronto, Washington University, Duke, 2018 UCLA Conference, University of Wash-

ington, and the Swiss Finance Institute. We also thank the Associated Press, which gener-

ously provided its news article data. All other data are publicly available from the sources

noted. Robustness tests and additional analyses are available in the Supplementary Materials

to this paper. All errors are our own. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

53

CUniversity of Chicago on behalf of the Accounting Research Center,2018

54 E.BLANKESPOOR,E.DEHAAN,J.WERTZ,AND C.ZHU

incorporate it. Instead we find that their trading responds to the trailing stock

returns presented in the articles. Our study raises questions about the efficacy

of regulations that aim to aid less sophisticated investors by increasing their

awareness of and access to accounting information.

JEL codes: D83; G12; G14; M41

Keywords: information costs; information awareness; information acquisi-

tion; individual investors; earnings announcements; trading volume; au-

tomation

1. Introduction

Individual investors often neglect value-relevant accounting information

(e.g., Lee [1992], Maines and Hand [1996], Hirshleifer et al. [2008], Taylor

[2010], Ayers, Li, and Yeung [2011]), and their portfolios underperform

because they chase attention-grabbing trends (Barber and Odean [2013]).

Securities and Exchange Commission (SEC) regulations like FD and XBRL

aim to help individuals make better trades by decreasing their costs of mon-

itoring and accessing accounting information.1However, it is difficult to

know whether these regulations are effective without understanding the

frictions that impede individuals’ use of accounting information. We inves-

tigate this question.

Whatever information an investor uses, incorporating an incrementally

informative signal will improve his or her valuations (Blackwell [1951],

Vives [2008]). Assuming accounting information is value relevant (which

we address below) and investors aim to maximize risk-adjusted returns,

we expect investors to use accounting information in trading decisions.

However, they may disregard accounting information if the cost of using it

outweighs the benefit (Grossman and Stiglitz [1980], Bloomfield [2002]).

Figure 1 describes three sequential steps to using accounting information

in trading and the costs of each. Two of these—awareness and acquisition

costs—have been a particular focus of SEC regulations. Our study examines

the extent to which awareness and acquisition costs impede individuals’ use

of accounting information in trading decisions.2

“Awareness costs” acknowledge that monitoring for the existence of

firms’ disclosure is costly, where “disclosure” could refer to a report or

a specific piece of information within a report (Merton [1987], Hand

[1990]). Investors who are unaware of their informational disadvantage

may continue to trade rather than withdrawing from the market (DellaVi-

gna and Pollet [2009], Hirshleifer, Lim, and Teoh [2009, 2011]). Thus, one

1Further discussion of SEC regulations is provided in section 2.

2Wealso discuss a third type of information cost—integration costs—and thepossibility that

behavioral biases prevent individual investors from using accounting information in trading

decisions.

INFORMATION AWARENESS AND ACQUISITION COSTS 55

Awareness

Defined: Become aware that

a disclosure exists. A

“disclosure” can be a report or

a piece of information within a

report.

Example Cost: The time and

effort to monitor for the

existence of firms’

announcements, and knowing

the specific contents of those

announcements.

Acquisition

Defined: Acquire the

disclosure or specific

informatio n within the

disclosure. Information is

“acquired ” when it is at hand in

a useable format.

Example Cost: The effort

necessary to extract quantitative

and qualita tive infor mation

from disclosures, and

converting that information into

useable metrics. Or, the cost of

outsourcing those efforts to

intermedia ries.

Integration

Defined: Combine and

integrate informatio n into

trading decision

Example Cost: Costs to

evaluate, combine, and

incorporate accounting

informatio n into valuation

models and trading

decisions, including the cost

of learning accounting and

financial statement analysis.

Disclosure Trad e

FIG. 1.—Sequential framework of information usage. This figure depicts the three sequential

steps for using an accounting disclosure in trading decisions. The lower portion provides

examples of the costs of accomplishing each step, any of which could prevent investors from

using accounting information in trading decisions.

explanation for investors’ neglect of accounting information is that, due to

limited resources, they are unaware of a disclosure.

Once aware of an accounting disclosure, investors must expend re-

sources to acquire information from the firm’s financial reports and sup-

plementary sources. Information is “acquired” once it is at hand and ready

for use in a valuation model (Maines and McDaniel [2000], Bloomfield

[2002]). Examples of acquisition costs include the time and effort needed

to obtain reports and convert raw data into statistics or the cost of outsourc-

ing those efforts (e.g., analyst reports or a Dow Jones feed).3Even when

investors are aware of a disclosure, acquisition costs could prevent them

from trading on it (Bhattacharya [2001]).

A challenge in disentangling awareness and acquisition costs from other

frictions is that investors’ information sets are typically unobservable. Our

study uses an archival setting in which awareness and acquisition costs are

reduced for a set of firms’ earnings announcements, which we use to isolate

and identify trading by individual investors with known information sets.

Our empirical approach uses the Associated Press’s (AP’s) staggered roll-

out of nationally distributed “robo-journalism” articles of firms’ earnings

announcements (Blankespoor, deHaan, and Zhu [2018], BDZ hereafter).

The existence and content of these algorithmically generated articles are

largely exogenous to the firm and its earnings announcement; BDZ find

the articles drive significant increases in trading by individual investors.

Our study exploits the feature that all articles present both a firm’s cur-

rent earnings and trailing stock returns in a standardized way, allowing us

to examine individuals’ trading choices when both accounting information

and technical trends are immediately at hand.

3Some papers use the term “acquisition costs” as a label for information costs more broadly

(e.g., Verrecchia [1982], Larcker and Lys [1987]), while others use it in a narrower context

(Reis [2006], Sims [2010], M¨

uller, Riedl, and Sellhorn [2015]). We define acquisition more

narrowly in order to best describe and differentiate between types of information costs.