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«W. Brooke Elliott University of Illinois at Urbana-Champaign Frank D. Hodge Michael G. Foster School of Business, University of Washington Lisa M. ...»

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Using Online Video to Announce a Restatement:

Influences on Investor Trust and Investment Decisions

W. Brooke Elliott

University of Illinois at Urbana-Champaign

Frank D. Hodge

Michael G. Foster School of Business, University of Washington

Lisa M. Sedor*

Michael G. Foster School of Business, University of Washington

May 2009

We thank Michael Bamber, Geoffrey Bartlett, Tina Carpenter, Margaret Christ, Lisa Gaynor,

Jackie Hammersley, Andrea Kelton, Molly Mercer, Uday Murthy, Janet Samuels, Mark Soliman, Jane Thayer, Brian White, doctoral-seminar participants at the University of Washington and the University of Illinois, and workshop participants at Arizona State University, the University of Georgia, and the University of Kansas for helpful comments; Jane Kennedy and Mark Soliman for assistance with obtaining participants; Seth Muriset for research support; Ling Harris and Walied Keshk for data entry; and Larry Gales for programming assistance. Frank Hodge acknowledges support of the Lane A. Daley Faculty Fellowship. We are grateful to the University of Illinois Research Board for financial support.

* Corresponding author - lsedor@u.washington.edu

Using Online Video to Announce a Restatement:

Influences on Investor Trust and Investment Decisions


In this paper, we conduct an experiment to investigate how using online video to announce an economically-significant event known to destroy trust in a firm’s financial reporting – a restatement – influences investment decisions and investors’ perceptions of management’s trustworthiness. We examine online video as a potential disclosure venue for restatements due to video’s recent, explosive growth as a corporate-communications tool. We also investigate whether the effects of disclosure venue on investors’ judgments and decisions differ depending on the level of responsibility assumed by a manager for the restatement. Our results reveal that when a CEO assumes full responsibility for a restatement, participants viewing the restatement announcement via online video make larger investments in the firm than do participants viewing the announcement via online text. However, this effect is not observed when the CEO assumes shared responsibility (along with industry peers) for the restatement. Our results also reveal that participants’ trust judgments partially mediate the influences that disclosure venue and assumed responsibility have on investment decisions. These findings are important given both the dramatic increase in the number of restatements over time and the Security and Exchange Commission’s recent emphasis on transitioning from traditional, paper-based to new, Internet-based disclosures.

Keywords: trust, investor, investment decision, responsibility, disclosure venue, online video

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“The loss of trust has reached epidemic proportions” (Weiss and Berney 2004). The failures of several of the largest public companies in the U.S. (e.g., Enron, World Com) and the near collapses of several other large firms (e.g., AIG, General Motors) have taken a toll on investor trust – a serious economic concern. Trust is the intent to accept vulnerability based on positive expectations regarding the intentions or behaviors of others (Rousseau, Sitikin, Burt, and Camerer 1998).1 Trust is violated when expectations are not met, and once violated is difficult to repair (Kim, Ferrin, Cooper, and Dirks 2004). Maintaining investor trust is a formidable challenge facing many public companies in the current environment, and the Internet is a powerful communication tool likely to aid these firms in their efforts (Harvard Management Update 2008).

We conduct an experiment to examine how using online video (a rapidly-growing segment of Internet content) affects investment decisions following an economically-significant event known to destroy trust in a firm’s financial reporting – a restatement.

Given the significance of restatements, it is essential that managers choose a disclosure venue that complements an important post-restatement communication objective: limiting damage to investor trust. We argue that investor sensitivity to social and psychological factors is likely to be particularly acute when a firm announces a restatement. Video is a significantly richer communication medium than is text (D’Ambra, Rice, and O’Connor 1998). Thus, we anticipate that presenting a restatement announcement via video will engage recipients and elicit stronger affective reactions from them than will presenting the same announcement via text. Limiting damages to trust is likely to be an important objective for a firm’s restatement announcement.

Apologizing is likely to mitigate damages to trust and yet, apologizing for trust violations due to 1 Trust has been examined in several disciplines (e.g., economics, organizational science, sociology, psychology, and communications). Consequently, a commonly-accepted definition of trust does not exist. We adopt a definition of trust from the organizational science literature which we further discuss in Section II.

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We integrate literature on communication media, trust, and affect to predict that disclosure venue (online video vs. online text) and assumed responsibility (full responsibility vs. shared responsibility) will have interactive effects on post-restatement investment decisions. We also examine the mediating role trust plays in the relationship among disclosure venue, assumed responsibility, and investment decisions.

We manipulate disclosure venue and assumed responsibility in an experiment with professional managers, taking graduate business classes, as participants. Participants assume roles as investment advisors for a mutual fund. Participants read information about a firm in the fund’s portfolio followed by a series of press releases. We designed the press releases to provide participants with ‘experiences’ likely to create positive expectations for the firm and elicited participants’ reactions to each press release. Next, participants make preliminary investment recommendations prior to learning that the firm will be restating its financial statements.

Participants view the restatement announcement via online video or online text. In the announcement, the firm’s CEO assumes either full responsibility (only his firm is restating) or shared responsibility (industry peers are also restating). Participants report their reactions to the firm’s announcement, make final investment recommendations, and respond to a series of questions designed to measure trust in both the firm and the CEO, participants’ propensity to trust, and other demographic information.

Consistent with our predictions, disclosure venue and assumed responsibility have an interactive effect on participants’ investment decisions. When the restating-firm’s CEO assumes full responsibility for the restatement, participants who view the restatement announcement via online video invest more in the firm and are more confident in the firm’s future performance than

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observed when the firm’s CEO assumes shared responsibility for the restatement. Our results also reveal that participants’ trust judgments mediate the influences of disclosure venue and assumed responsibility on investment decisions.

We use an experiment to investigate whether using online video affects investment decisions following a restatement for several reasons. First, archival data to examine this question does not exist. We exploit the comparative advantages of an experiment to examine how a rapidlygrowing communication tool, online video, affects investor judgments prior to its widespread application in practice (see Libby, Bloomfield, and Nelson 2002). Second, using an experiment allows us to equate characteristics of both the restatement announcement (e.g., extent, precision, content) and the restating firm’s CEO across experimental conditions while manipulating disclosure venue and assumed responsibility. Third, we obtain measures that allow us to identify the mechanisms (e.g., perceptions of trust, affective reactions) through which online video presentations and assumed responsibility influence investment decisions. As with all experimental research, we note that a limitation of our approach is that we are unable to measure the economic consequences associated with any effects we document.

Given both the necessity of re-establishing investor faith in the capital markets and the rapid growth in the use of the Internet and online video presentations, understanding the influence of this disclosure venue on investor judgments and decisions is important. These effects become increasingly important as the Securities and Exchange Commission (SEC) promotes a shift from traditional paper-based to new Internet-based disclosures (Goff 2007; SEC 2007a). Managers believe that online video provides unique opportunities for a diverse set of existing and potential investors to both see and hear managers talk about their business – an opportunity seldom

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predicts, “…with an entire generation now being weaned on Web-based video sites such as YouTube, future investors will undoubtedly embrace video over print” (Goff 2007).

Our findings contribute to academic research and to practice in several ways. First, we expand the literature regarding the trustworthiness of management’s disclosures by isolating and investigating whether firms can more effectively maintain investor trust following a restatement by using online video rather than a standard text-based press release. Prior research on repairing trust tends to rely on simplified settings and a priori trust violations (e.g., students acting as managers interviewing a prospective employee who violated the trust of a previous employer) (Kim et al. 2004, 2006). To our knowledge, ours is the first study to examine how online video communication following a trust-destroying event is likely to influence subsequent investment decisions via investors’ perceptions of managerial trustworthiness.2 Maintaining investor trust at the macro-economic (market) level necessarily begins with the efforts of market participants to manage trust at the micro-economic (firm) level. In addition, our results provide information relevant to the SEC’s current agenda of leveraging the benefits of technological advances in the financial reporting process.

Second, our evidence provides managers with information on how disclosure venue interacts with assumed levels of responsibility for a restatement to influence investors. This evidence is important given the dramatic increase in the number of restatements over time and the enormous losses in market capitalization suffered as a result (GAO 2006). Given these costly trends, effectively managing investor trust is one of the biggest challenges facing many public companies today.

2 Clements and Wolfe (2000) examine how viewing a basic financial report in either video or text influences participants’ judgments of a firm’s viability for both career and investment opportunities.

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and develops the hypotheses. Section III describes the experimental design and method. Section IV presents results, and Section V summarizes and concludes.

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Trust and Trust Violations Consistent with the organizational science literature, we define trust as a psychological state in which one accepts vulnerability based on positive expectations regarding another’s intentions or behaviors (Rousseau et al. 1998).3 Trust, as a psychological state, is distinct from behaviors (e.g., cooperation) and choices (e.g., taking a risk) that either result from or give rise to trust (Rousseau et al. 1998). Trust is influenced by both affect (feelings/emotions) and cognition (expectations/beliefs) (Flores and Solomon 1997). Feelings and expectations about another’s benevolence, competence, integrity, and reliability are important components of trust (Cummings and Bromiley 1996; Mishra 1996; Fuller, Serva, and Benamati 2007). Positive expectations of others along these dimensions provide the foundation for initial trust (Zucker 1986; Sydow 2006).

As one’s positive expectations are confirmed by another’s behavior over time, trust is developed (Boon & Holmes 1991; Kramer 1996; Brockner, Siegel, Daly, and Tyler 1997).4 Trust is violated when another’s behavior is inconsistent with one’s positive expectations (Hilton, Fein, and Miller 1993; Brockner et al. 1997; Dirks and Ferrin 2002; Kim et al. 2004).

3 Although we focus on trust at the individual level, trust is also very important in organizational and interorganizational settings (Williamson 1975; Zucker 1986; Doney & Cannon 1997; Ba & Pavlou 2002; Nooteboom 2006; Sydow 2006). Trust benefits organizations by increasing exchange efficiency (Smith, Carroll, and Ashford

1995) as well as lowering both agency and transaction costs (Limerick and Cunnington 1993; Jones 1995; Plender 2003). Trust is related positively to firm performance, customer satisfaction, and competitive advantage (Handy 1995;

Cummings and Bromiley 1996; Balasubramanian, Konana, and Menon 2003).

4 Possessing positive expectations has also been described as a perceived probability (Bhattacharya, Devinney, and Pullutla 1998) or confidence (Jones and George 1998) that another’s intentions or behaviors will be consistent with expectations.

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authority are examples of behaviors that violate trust (Bies and Tripp 1996). Trust violations tend to evoke suspicion and increase an individual’s sensitivity to information regarding the intentions and motives underlying another’s behavior (Hilton et al. 1993). Information regarding another’s intent and motivation exerts significant influence on the propensity to assign responsibility and blame for a negative outcome (Alicke 2000; Shaver 1985) and consequently, affects trust (Korsgaard, Brodt, and Whitener 2002; Lind 1997; Korsgaard, Schweiger, and Sapienza 1995).

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