The Effect of a Cautionary Notice on Investors' Reactions to More and Less Readable Disclosures

Managers appear to strategically use discretion over disclosure language to reduce the effect of bad news and/or amplify the effect of good news. We test how a cautionary notice highlighting management's discretion over disclosure language affects investors' reactions to more and less readable disclosures. We find that a cautionary notice causes investors to reduce their valuation and investment desirability judgments when readability is consistent with management's incentives—that is, when bad news disclosures are less readable and when good news disclosures are more readable—but not when readability is inconsistent with a strategic motivation. Our results should be informative to regulators, given their interest in both promoting more readable disclosures and protecting investors