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Professional investors and the decision usefulness of financial reporting

Stewardship and valuation objectives

The results indicate that objectives do matter. Professional investors whose objective was to value the company assessed financial accounting information to be more relevant than those assessing the performance of management. This result pertains to financial reporting information overall and for individual line items in the financial statements. In contrast, the existence of accounting-based managerial compensation arrangements had no significant effect on professional investors’ assessments of the representational faithfulness of financial reporting information.

In line with prior research, the study finds that professional investors view information in the income statement as more relevant than balance sheet line items, especially where investors’ objective is to assess the performance of management. The qualitative analysis suggests that, regardless of their objective, investors are concerned with discretion and managerial judgement for certain balance sheet line items (such as fair values) and, consequently, information in the income statement as well (such as changes in fair values).

Turning to the alternative information sources that professional investors use, in line with prior studies and despite the major changes to the information environment in recent years, professional investors view financial reporting information as a primary input to their decisions, even though they are aware of its shortcomings. This judgement is even more pronounced when their objective is to assess managerial performance and where there are relatively fewer alternative information sources available. Alternative information sources are sometimes obtained directly from the firm and from third-party sources. Such sources include qualitative and quantitative non-financial information about the firm and its management, information about the industry and competitors, information about product markets, and, to a lesser degree, information about corporate governance and the general macro-economic environment.

Both qualitative and quantitative results from the study indicate that professional investors’ assessments of corporate governance mechanisms significantly affect how they view financial reporting information. In particular, investors seem aware of the risks to representational faithfulness posed by linking managerial compensation to accounting data (e.g., that it may amplify preparers’ tendencies to manage earnings), yet they are less concerned about these risks when they judge overall corporate governance mechanisms to be sound.

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