Connecting the Dots : Helping Investors Use Risk Disclosures When Evaluating Financial Statements

The SEC recently required a two-page summary of risk factor disclosures with the purpose of improving the decision-usefulness of firm risk factor disclosures. This study tests the usefulness to investors of (1) this new requirement and (2) a novel proposal that involves hyperlinking financial statement line items with related risk factor disclosures. The hyperlinking proposal is based on theories that indicate connecting risk disclosures directly to affected financial statement line items will facilitate greater causal coherence. We test both potential improvements in an experiment with retail investors. We find evidence that (a) hyperlinking significantly affects investor judgments and (b) the SEC's recent summarization requirement does not. Two supplemental experiments, one with professional investors, further investigate the process of the hyperlinking effect. Our findings question the effectiveness of the SEC's recent requirement and suggest a potential policy that could improve investor understanding of risk disclosures, a desired outcome for policy makers