Nonfinancial Measures and Fraud Risk: Evaluating Investors' Reactions to Greater Transparency

Abstract

ABSTRACT We examine whether increased transparency in the comparison of financial measures and nonfinancial measures (NFMs) influences nonprofessional investors' reactions to the risk of fraudulent financial reporting. We consider a comparison of key financial measures and NFMs to be transparent when the relevant information is presented in close proximity and formatted to provide an easy comparison of the individual measures. We manipulate the presence of an NFM red flag and the transparency of the comparison of financial measures and NFMs. We find that when the NFM red flag is present (i.e., higher fraud risk) and transparent, investors choose lower investment levels. However, without increased transparency, as is typical in the current reporting environment, we observe that investors are more likely to increase their investment levels in firms with elevated fraud risk. Additionally, we observe that the effect of transparency on investment levels is driven by investors with greater investing experience. Data Availability: Contact the authors. JEL Classifications: M40; M41; M48.