1. Investigating the Reaction of Relatively Unsophisticated Investors To Audit Assurance on Firm-Released News Announcements J. E. Hunton – Bentley College J. L. Reck – University of South Florida R. E. Pinsker – Old Dominion University

2. Motivation  Individual investors, an understudied group, are gaining sufficient numbers to ‘move’ the market.  Information technology allows for ubiquitous access to news announcements.  It is important to investigate the perceived value of independent assurance to relatively unsophisticated investors.

3. Background  Investors use information to help them determine the value of a firm (Watts and Zimmerman 1986; AICPA 1996; Beaver 1998).  Incomplete information, hampers investors’ ability to arrive at accurate valuations.  Incomplete information increases investors’ perceptions of information risk (Masters 1989).

4. Background  As Miller (2002, p 71) succinctly states: Incomplete information fosters [investor] uncertainty. Uncertainty creates risk. Risk motivates investors to demand a higher rate of return. Demand [for a higher rate of return] results in a higher cost of capital and lower security [stock] prices.

5. Background  Incomplete information has been defined in terms of information asymmetry and information quality (Marston 1996; Beaver 1998; Miller 2002).  Of particular interest to the current study is the quality of information. at least one characteristic of quality information is reliability (FASB 1980). Information that is unreliable increases investor uncertainty, thus triggering the sequence of events identified by Miller (2002).

6. Background  By providing reliable information, firms can reduce investor uncertainty, decrease risk and increase stock prices (King et al. 1990; Olsen 1997; Kennedy et al. 1998).  Assessing reliability may be an especially difficult task for retail investors who are generally viewed as less sophisticated than institutional investors (Olsen 1997; Beaver 1998).

7. Prior Research  A large body of research supports the value of the assurance function in improving the quality of information (“information hypothesis”) (e.g., Fama and Laffer, 1971; Wallace 1980, 1987) →  Research studies since the 1980’s continue to support the information hypothesis, for instance →

8. Prior Research  An experiment by Pany and Smith (1982) found an association between auditor assurance and perceived information reliability.  A more recent study (Hodge 2001) found a moderately strong, positive correlation between reliability of information and the perceived earnings potential of a firm.

9. Prior Research  Prior research indicates a positive association between audit functions and market value.  However, all of the prior research has focused on relatively sophisticated user groups.  Hence, there remains a question as to whether unsophisticated investors will have sufficient knowledge of auditors/audit services to allow for a positive association between audit functions and market value.

10.  H1: Stock prices will be greater when management-provided information is accompanied by independent auditor assurance, as compared to no assurance.  There is no indication that unsophisticated investors would consider the presence of audit assurance to be a negative factor, but the investor may not value audit assurance enough to significantly adjust market prices. Research Hypotheses → H1

11.  H2: The stock price increase related to audit assurance will be greater for a series of positive information releases, as compared to negative information releases. Research Hypotheses → H2

12.  H3: Stock price variance will be smaller when the information is accompanied with independent auditor assurance, as compared to no assurance. Research Hypotheses → H3

13. Experimental Design  The experiment employed a 3 (direction of news: positive, mixed or negative) by 2 (assurance: absent or present) between-subjects design.  The entire experiment was computerized via Visual Basic programming.  The program randomized participants into treatment conditions  The order of dependent variable measures, manipulation check questions and post- experiment psychological debriefing items were randomized.

14. Research Procedure Welcome Screen Training Screens Company Background News Announcement 1-10 (++ : without Assurance) News Announcement 1-10 (-- : without Assurance News Announcement 1-10 (+- : without Assurance News Announcement 1-10 (++ : with Assurance) News Announcement 1-10 (-- : with Assurance News Announcement 1-10 (+/- : with Assurance Manipulation Checks Post-Experiment Questions Demographic Items

15. Sample Computer Screens

18. Usable Sample Size Direction of News AssuranceTotal by Direction AbsentPresent Positive303262 Mixed282957 Negative283260 Total by Assurance 8693179

19. Demographic Results Age Brackets: 18-22 9 23-29143 30-39 27 Gender: Female120 Male 59 College Level: Seniors 18 Masters157 Ph.D.s 4 LiberalArtsMajors

20. Overall Means (S.D.) Direction of News AssuranceTotal by Direction AbsentPresent Positive58.41 (1.77) 63.27 (1.33) 60.92 (2.90) Mixed50.52 (0.53) 53.74 (0.47) 52.16 (1.75) Negative43.63 (1.49) 46.80 (0.83) 45.32 (1.97) Total by Assurance 51.03 (6.27) 54.63 (6.96) 52.90 (6.87)

21. SourceSum of Squares d.f.Mean Square F-ratio p- value Prior Investing Experience 0.61 0.4.533 Risk of Investing in Universal 10.01 7.0.009 Risk Propensity0.11.808 Enron-AA Impact0.71 0.5.476 Direction of News5621228111978.001 Assurance6211 437.001 Interaction3021510.001 Error Term2401691.4 ANCOVA Model of 10 th Stock Price Valuation

22. H1 - Confirmed

23. H2 - Confirmed

24. Third Hypothesis (H3)  Variances will be greater in all ‘direction of news’ conditions (++, --. +-) with assurance, as compared to without assurance.  H3 was only supported in the negative news (--) condition.  The mixed results associated with H3 were similar to prior behavioral studies that have had difficulty finding consistent results using variance as a measure of risk/uncertainty (Hodder et al. 2001).

25. Summary  Audit assurance can significantly increase the value individual investors assign to stocks.  The results held regardless of whether the assurance was provided on a series of positive, negative or mixed sign disclosures.  The increase in stock price related to assurance was greatest when the firm released a series of positive information disclosures.

26. Summary  Stock price variance was consistently and significantly smaller when audit assurance was provided on negative news disclosures.  The variances surrounding no assurance positive disclosures were larger than the variances surrounding the no assurance negative disclosures.  Hence, it appears the positive information provided by the firm was deemed less reliable than negative information

27. Limitations  Usual external validity concerns related to experiments  Arbitrary choices made for the positive/negative news announcements  Length of the information series  Participant pool  Cost/benefit considerations

28. Future Research  Information overload concerns induced by continuous reporting/assurance  Why risk (variance) was reduced more in the negative, as compared to positive, news condition.  Impact of other credible assurance providers on perceptions of reliability  Impact of having management certify the ‘truthfulness’ of disclosures on perceptions of reliability.