Do Investors Pay Attention to Accounting Information?

Alina Lerman, assistant professor of accounting, studies the role of accounting information in capital markets and how participants with different degrees of sophistication respond to the same information.

"Individual investors are a little bit of an enigma, especially in the accounting profession," says Lerman, who joined the Yale SOM faculty in July. "It's really an open question, what kind of information individuals actually pay attention to."

Lerman uses message boards as one path to get into the minds of these investors. She analyzed about two million messages for 1,800 firms over a one-year period on Yahoo's public message boards. She found that individual investors not only pay attention to accounting information, but they pay attention to a surprisingly wide range of accounting items.

"Obviously, they talk about earnings. But they also talk about revenues, cash, assets, and about items that we don't necessarily assume to be in the realm of understanding of the individual investor, like impairments."

Individual investors also talk about these items when they should be talking about them. Lerman finds that accounting discussion on the message boards spike around earnings announcements, and even around releases of 10-Q reports and 10-K reports of smaller firms. "Interestingly, they also pay attention to 8-Ks, timely reports that firms file with the SEC upon experiencing a material event."

She finds that investors also discuss accounting information more when there is a lack of information available to them — for example, when there are few analysts following a firm or when there is more uncertainty about the information, such as when analysts disagree. "In the climate of greater uncertainty, investors are undertaking extra effort to supplement their information and understand the financial reporting better."

Investors are paying attention, but does that translate into learning or other benefits? Although for some firms high levels of accounting discussion on the message boards appear to be associated with an improvement in the ability of investors to collect or process information, the causality of this is not clear, cautions Lerman. "Do individuals become better informed because they talk on message boards about a certain accounting event? Or does the event itself cause them to dig deeper via other channels as well: to read more footnotes and analysts reports, to listen to conference calls more carefully?"

Lerman has studied the reactions of different market participants from other perspectives as well. She recently examined who pays attention to accrual information by looking at whether investors who place trades of different sizes react correctly to the accrual signal, a gauge of the quality of a firm's earnings.

"The majority of investors don't react to the accrual signal correctly, which explains why there persists an accrual anomaly, the negative association between the reported accrual amounts and future stock returns."

According to Lerman's findings, the majority of investors —  those that could be categorized as small-or medium-sized traders — don't appear to react to the accrual signal at all. The largest investors, those trading 5,000 shares or more per trade, appear to be the only group who reacts to it in the correct direction, but they only do so when the contemporaneous earnings signal is positive.

"When the earnings miss analyst expectations, large traders disregard the accrual signal, likely due to short-selling constraints faced by many institutional investors."

Among other topics that Lerman has explored in her research is the market reaction to material events disclosed in SEC 8-K filings, the changes in firm visibility associated with instances of high trading volume, and the differential responses of investors, analysts, lenders, and credit rating agencies to new accounting regulation.