Estimate-related Disclosures, Investor Mindset and the Illusion of Precision in Financial Statement Estimates

This study examines the joint effect of disclosed measurement information and investor mindset on investors' judgments of estimate precision and firm value. Consistent with psychology theory, results reveal that short horizon investors adopt a relatively concrete mindset and long horizon investors adopt a relatively abstract mindset. As a consequence, disclosing that the fair value of an impaired asset was derived using a model with unobservable inputs strongly influences short horizon investors’ judgments of estimate precision. By contrast, disclosing this information has significantly less impact on the precision judgments of long horizon investors. Further evidence indicates that mindset and disclosed measurement information jointly influence investors’ valuation judgments in a way that is inconsistent with standard models of firm value. Specifically, long horizon investors’ valuation judgments reflect the negative effect of an asset impairment with no significant effect of differences in measurement, consistent with concerns about an illusion of precision in financial statement estimates. Contrary to such concerns, however, short horizon investors’ concrete mindsets lead them to interpret higher (lower) estimate precision as a positive (negative) signal about firm value in its own right. Thus, rather than placing greater weight on a more precisely measured estimate, short horizon investors’ fixation on measurement causes them to discount the negative effect of the asset impairment on firm value when it is measured relatively precisely, but amplify the negative effect in response to imprecise measurement. These results may be useful in judging the effectiveness of existing and proposed disclosures in communicating information about estimate precision. Further, this study makes a unique contribution to the accounting literature by providing theory and empirical evidence that differences in mindset influence investors’ interpretation and use of accounting information in ways that are likely unanticipated by regulators and standard setters relying on standard economic theory.