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DOI: 10.1111/1475-679X.

12053
Journal of Accounting Research
Vol. 52 No. 3 June 2014
Printed in U.S.A.

The Impact of Recognition Versus


Disclosure on Financial
Information: A Preparers
Perspective
S H A N A M . C L O R - P R O E L L A N D L A U R E E N A . M A I N E S
Received 28 August 2013; accepted 27 February 2014

ABSTRACT

We investigate whether recognition on the face of the financial statements


versus disclosure in the footnotes influences the amount that financial managers report for a contingent liability. Using an experiment with corporate
controllers and chief financial officers, we find that financial managers in
public companies expend more cognitive effort and exhibit less strategic bias
under recognition than disclosure. This difference appears to be associated
with capital market pressures experienced by public company managers as
we find that both the cognitive effort and bias exhibited by private company
M.J. Neeley School of Business, Texas Christian University (TCU); Kelley School of Business, Indiana University.
Accepted by Douglas Skinner. We thank Jason Brown, Andy Call, Tina Carpenter, Rick
Cazier, Margaret Christ, Ted Christensen, Lisa Gaynor, Steve Glover, Max Hewitt, Pat Hopkins, Lisa Koonce, Mark Nelson, Ray Pfeiffer, Chad Proell, Kathy Rupar, Casey Schwab, Geoff
Sprinkle, Jane Thayer, Jeff Wilks, David Wood, Arnie Wright, Teri Yohn, Mark Zimbelman,
an anonymous reviewer, and workshop participants at the following universities for helpful
comments on prior versions of the paper: Arizona State, Brigham Young, Cornell, Georgia,
Indiana, Northeastern, Texas Christian, South Florida, and Texas-Austin. We greatly appreciate the help of Diane Biagioni and Todd Stinson in creating the experimental instrument, and
Spencer Anderson, Devon Erickson, Adam Esplin, Ken House, Tim Keune, and Gabby Wang
for research assistance. We thank the KPMG Professorship at the Kelley School of Business,
the M.J. Neeley School of Business, and the Wisconsin School of Business for their generous
financial support. Finally, we thank the financial professionals who participated in the study.
671
C , University of Chicago on behalf of the Accounting Research Center, 2014
Copyright 

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managers are unaffected by placement. As a result, public company managers make higher liability estimates for recognized versus disclosed liabilities.
Their liability estimates are similar to those of private company managers for
recognition but lower than private company managers estimates for disclosure. Our results have implications for auditors and financial statement users
in evaluating recognized versus disclosed information for public and private
companies.

1. Introduction
We investigate whether placement of information on the face of the financial statements (recognition) versus in the footnotes (disclosure) influences the amount financial managers in public and private companies report for a contingent liability. Understanding whether and how placement
influences the judgments and decisions of managers who prepare financial
statements is important because preparers establish the initial reliability of
financial information.1 While research finds that auditors tolerate less misstatement in recognized than disclosed information (Libby, Nelson, and
Hunton [2006]), it is unknown whether auditors actions serve to offset
or exacerbate reliability differences in preaudit information. Thus, our research is important to auditors who attest to information reliability, as well
as to users, regulators, and standard setters who face consequences from
reliability differences remaining in audited financial information.
In addition to examining whether preparers estimates differ between
recognition and disclosure, we address two related issues associated with
these potential differences. First, we examine how differences in preparers estimates arise. Specifically, we propose that differences between recognized and disclosed amounts arise from two sources: (1) preparers
choice of approaches for arriving at reasonable ranges for the estimate,
and (2) preparers choice of point estimates within those ranges. Drawing
on Bernard and Schipper [1994], we hypothesize that capital market pressures from standard setters, investors, and auditors/regulators differentially
affect preparers motivation to engage in effortful information processing
when making contingent liability estimates that are either recognized or
disclosed. Similarly, we expect that capital market pressures will also affect
the extent to which preparers choose more justifiable estimates that are in
the middle of the range of possible outcomes, rather than biasing financial

1 Historically, the Financial Accounting Standards Board (FASB) has used the term reliability to describe information that is reasonably free from error and bias and faithfully represents
what it purports to represent (FASB [1980]). However, the FASB recently replaced the term reliability with representational faithfulness to describe information that is complete, free from
error, and neutral (FASB [2010]). Despite this change, the term reliability continues to appear in the FASB Codification (e.g., FASB ASC 820, FASB [2013b]) and in recent accounting
literature (e.g., Kadous, Koonce, and Thayer [2012]). We use the term reliability throughout
the paper to refer to characteristics related to the 1980 definition, that is, information that is
free from error, unbiased, and faithfully represents what it purports to represent.

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673

information by choosing estimates toward the lower or upper end of the


range. We leverage our comparative advantage as experimentalists to capture information about preparers judgment process when making the accounting estimate (Libby, Bloomfield, and Nelson [2002]) to provide insight on the mechanisms that lead to preparers estimates.
Second, to provide further insight on capital market forces as the source
of differences in recognized versus disclosed estimates, we compare public
company managers judgments to identical judgments made by financial
managers in private companies. We argue that private company preparers
form a reasonable basis for comparison because they have the requisite
level of expertise, but are less likely to be influenced by the capital market pressures that face public company preparers. Thus, we expect that
private company preparers will be less likely to exhibit differences in the
amount of cognitive effort and bias that they use when making recognized
versus disclosed estimates. We find it particularly interesting to examine
differences between public and private company preparers as prior literature in this area has examined differences in recognized, postaudit information, but has not examined whether differences exist in disclosed information, and/or in preaudit information (Givoly, Hayn, and Katz [2010],
Hope, Thomas, and Vyas [2013]).
To examine these issues, we conduct an experiment with 113 experienced preparers (primarily controllers and chief financial officers (CFOs))
using a 2 2 + 1 between-subjects design. Preparers determine the amount
of a contingent liability for costs associated with a chemical used in the
firms manufacturing process that appears to have had deleterious effects
on employees health. For the 94 participants in the 2 (placement) 2
(company trading status) external financial reporting conditions, we manipulate whether financial reporting standards require the estimate to be
reported as an expense in the income statement and liability on the balance sheet or only disclosed in the footnotes. Company trading status is
a measured variable, with participants currently working for either public
or private companies. Finally, in the +1 internal reporting condition, 19
participants provide their best estimate of the amount that the company
will have to pay related to the chemical for internal planning purposes
(i.e., not for financial reporting purposes). Thus, the +1 condition assesses
participants beliefs about the ultimate resolution of the contingent liability and provides a benchmark for assessing managers external reporting
estimates.
We use both self-reported and computer-tracked process data to examine how differences in estimates arise. We find that public company managers use more effortful approaches for estimating recognized liabilities
than disclosed liabilities. In contrast, private company managers use similar approaches regardless of whether the liability is recognized or disclosed.
We also find that public company managers are more likely to choose estimates below the midpoint of their expected range for contingent liability payments when the estimate will be disclosed versus recognized. We

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observe no such difference for private company managers. Thus, our process results indicate that public company managers both choose more effortful approaches and exhibit less strategic bias under recognition than
disclosure. In contrast, private company managers effort levels and amount
of strategic bias are similar regardless of placement.
Further, the results of a mediation analysis reveal that preparers effort
levels and extent of strategic bias affect the liability estimate that is reported
in the financial statements, with public company financial managers reporting a higher amount when a contingent liability is recognized than when
disclosed and private company managers reporting a similar amount regardless of placement. Finally, we find that in the recognition condition
both public and private company managers external financial reporting estimates do not differ from the internal reporting groups average estimate
of future payments related to the contingent liability. In the disclosure condition, however, while private company managers external estimates do
not differ from the internal estimate, public company managers external
estimates are significantly lower than the internal reporting estimate. Thus,
we conclude that preparers external reporting estimates are generally consistent with their beliefs about the ultimate resolution of the liability with
the exception of public company managers disclosed estimates. One possible explanation for this result is that public company managers, who must
disclose a contingent liability estimate, are more concerned about potential
scrutiny from the plaintiffs legal counsel than they are about scrutiny from
auditors and users. In contrast, public company managers who recognize a
contingent liability estimate must balance the scrutiny of attorneys against
the greater scrutiny of auditors and users. Finally, private company managers would not have as much concern about scrutiny from the plaintiffs
legal counsel because their financial statements are not publicly available.
Our research is of interest to academics, auditors, and financial statement users. From an academic perspective, our research adds to the relatively sparse accounting literature on financial reporting practices associated with preparers and preaudit information. In contrast to prior research
that has held constant the amount of preaudit misstatement (Libby, Nelson,
and Hunton [2006]), or has investigated the reliability of postaudit financial information (Davis-Friday, Liu, and Mittelstaedt [2004]), our research
examines whether and how information location affects preaudit reliability.
Thus, we answer calls for evidence concerning managements perspective
on the reliability of disclosed information relative to recognized information (Libby and Emett [2014], Schipper [2007]).
Our findings also relate to the academic literature on the quality of financial reporting in public versus private firms. Recent studies in this area tend
to find that public firms have higher quality (recognized) earnings than
private firms (Burgstahler, Hail, and Leuz [2006], Hope, Thomas, and Vyas
[2013]). While we do not examine all factors that could affect differential
financial reporting quality between public and private firms, our findings
suggest that public companies do not necessarily have higher quality disclosed information than private companies. In addition, our findings suggest

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675

that the impact of auditor scrutiny on preparers judgments and decisions


differs between public and private companies, and thus should differentially influence users reliance on audited information (Minnis [2011]).
Future research can further investigate the interactive effects of preparer
and auditor judgments and decisions on the relative quality of financial
information presented outside of the face of the financial statements for
public versus private firms.
Finally, from a practical perspective, our research is useful to auditors
and financial statement users who are concerned about reliability of information in the financial statements. Our findings support auditors and
users expectations for public companies that recognized numbers generally are more reliable than disclosed numbers, and we document that this
difference originates with preparers. Further, our results indicate that these
differences arise in part due to the level of effort that preparers use to assess
recognized versus disclosed information. For auditors, these results suggest
that preparers may resist correction of recognized amounts more than disclosed amounts in part because they have invested more effort in estimating
recognized amounts. Thus, auditors should be aware that not all client resistance is necessarily motivated by a desire for biased reporting. For users, our
results, in conjunction with those of Libby, Nelson, and Hunton [2006], indicate that the judgments of auditors and managers work in combination to
produce more reliable recognized amounts than disclosed amounts. Thus,
users propensity to discount disclosed information relative to recognized
information appears reasonable given the current financial reporting environment.
The remainder of this paper is organized into four sections. The next
section provides background and develops the hypotheses, and section 3
describes the experiment used to test these hypotheses. Section 4 presents
the results, and section 5 provides a summary and discussion of the
results.

2. Background and Hypotheses


2.1

RESEARCH ON PLACEMENT AND FINANCIAL INFORMATION RELIABILITY

Research on whether corporate financial managers differentiate between


recognition and disclosure when determining financial information is relatively sparse and is typically based on published financial statement numbers rather than preparers preaudit numbers. These studies provide mixed
evidence about the relative reliability of recognized versus disclosed information. For example, Wiedman and Wier [1999] find that firms unconsolidated subsidiary debt increased when the FASB requirement switched
from disclosure to recognition, suggesting that firms were understating
the previously disclosed amount. In contrast, research on stock-based compensation documents that companies estimates for stock option compensation are more downwardly biased when recognized in the financial
statements than when disclosed in the footnotes (Johnston [2006],

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Standard Setters
Economic Differences
(Greater Relevance or
Reliability of Recognized
Information)

Financial Statement Users


Economic Differences Greater
Weighting
Processing Differences of Recognized
Information

Auditors/Regulators
Economic Differences
Users Greater Weighting

Greater
Scrutiny of
Recognized
Information

Preparers
Level of Care for
Recognized vs.
Disclosed Information
Preparers
Strategic Bias for
Recognized vs.
Disclosed Information
Contracts/Regulations
Estimate

Compensation Contracts
Debt Covenants
Income Taxes

FIG. 1.Capital market forces that affect preparers estimates. A + () sign indicates that a
force increases (decreases) level of care or strategic bias. The line thickness illustrates the
strength of a force, while a dotted line represents a force not considered in our experiment.

Choudhary [2011]). Overall, the scarcity of research in this area and mixed
results of the existing research suggest that further investigation of preparers treatment of recognized versus disclosed information is warranted.
As defined by the FASB, information is reliable if it is free from error,
unbiased, and represents what it purports to represent (FASB [1980]). We
examine two possible ways by which preparers influence the reliability of
initial financial information. First, preparers affect reliability through the
approaches they use to arrive at financial amounts. By choosing a higher
standard of care in the approach used to arrive at financial information,
preparers improve the ex ante expected reliability of that information because a more careful approach decreases the probability that financial information will contain errors. Second, for some financial information, such
as estimates, a given approach provides a range of numbers from which preparers must choose a point estimate to report in the financial statements.
Preparers can influence the reliability of this point estimate by strategically
choosing a number toward one end of the range, that is, biasing the information in one direction. Thus, both choice of an approach level of care
and strategic bias influence the reliability of preparers financial information. To date, evidence on these two avenues tends to be either anecdotal
or circumstantial (Schipper [2007]).
Drawing on Bernard and Schipper [1994], we argue that the level of
care and strategic bias that preparers exhibit is determined primarily by
forces associated with a firms participation in the capital markets. In
figure 1, we describe the forces exerted by different participants in the

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capital marketsnamely, standard setters, users, and auditors/regulators


and the pressures that they create for preparers.2

2.2

STANDARD SETTER, USER, AND AUDITOR VIEWS TOWARD RECOGNIZED


VERSUS DISCLOSED INFORMATION

As shown in figure 1, the distinction between recognition and disclosure


originates with standard setters because the FASBs Conceptual Framework
suggests a higher threshold for recognition than for disclosure. That is,
Statement of Financial Accounting Concepts No. 5 specifies that information must be relevant and measured with sufficient reliability to be recognized in the financial statements (FASB [1984]). Information that fails to
meet these criteria is relegated to disclosure in the footnotes. Thus, standard setters, at least implicitly, view recognized information as more useful
than disclosed information because recognized information is presumably
more relevant and/or reliable. The importance that standard setters ascribe to recognized information creates the expectation that preparers will
demonstrate a higher level of care (represented with a plus sign in figure
1) and less strategic bias (represented with a minus sign in figure 1) for recognized information than for disclosed information. Importantly, standard
setters views toward recognition versus disclosure also have implications
for users and auditors/regulators. We discuss each group in turn.
Both the experimental and archival literatures find that users (investors)
generally impound recognized information more strongly than disclosed
information in their investment judgments and decisions (Davis-Friday, Liu,
and Mittelstaedt [2004], Fredrickson, Hodge, and Pratt [2006], Michels
[2013]). As indicated in figure 1, and as articulated by Bernard and Schipper [1994], there are at least two reasons why financial statement users
might react differently to recognized and disclosed information. First, as
a result of standard setters view toward recognition versus disclosure, users
may rationally perceive that firms report the most important financial information on the face of the financial statements, that is, they believe that recognized information in general is more relevant and reliable than disclosed
information. This perspective suggests that economic differences between
recognized and disclosed numbers lead users to weight recognized information more heavily than disclosed information.
2 Preparers recognition and disclosure judgments may also be determined by the use of financial statement information in contracts (e.g., compensation contracts, debt covenants) or
regulatory reports (e.g., income tax reporting). However, contracting arrangements and regulatory reports typically are tied to and influence recognized information only (e.g., reporting
lower numbers for expenses in order to meet earnings benchmarks for bonuses). Overall, the
direction and level of the potential bias in recognized information is specific to the firms contractual and regulatory parameters, and is not the focus of our research. Thus, as discussed in
more detail in section 3, we minimize the effect of these forces in our experimental materials.
We include contractual and regulatory forces in figure 1 only for the sake of completeness,
and represent the effects on preparers with dotted lines to signify the weak relationship in our
setting.

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Alternatively, there may be cognitive processing differences associated


with recognized versus disclosed information. Financial statement users
may experience cognitive overload in processing footnote information or
may simply find the varying formats of disclosed information more difficult
to process and integrate than the more standardized format of the financial statements.3 Regardless of whether users interpretation of recognized
versus disclosed information is driven by rational economic differences
and/or by processing difficulties, the fact that users generally place more
weight on recognized information than on disclosed information gives preparers not only the incentive to exhibit more care, but also the incentive
to exhibit greater strategic bias to make the firm look more favorable (as
represented by the plus signs in figure 1).
As shown in figure 1, users greater weighting of recognized versus disclosed information leads auditors and regulators to perceive recognized information as more material than disclosed information because it has more
influence on users judgments. This perception, along with the direct influence of standard setters perceptions of greater relevance and reliability for
recognized information, results in greater auditor and regulator scrutiny
for recognized than for disclosed information, particularly in the post
Sarbanes-Oxley (SOX) era (Cohen, Dey, and Lys [2008]). Consistent with
this expectation, experimental evidence finds that auditors allow less error in recognized than disclosed information (Libby, Nelson, and Hunton
[2006]). Thus, due to auditor/regulator scrutiny, preparers are likely to
exhibit both more care for recognized information (as represented by the
plus sign in figure 1) and less strategic bias (as represented by the minus
sign in figure 1).

2.3

RECOGNITION VERSUS DISCLOSURE AND PREPARERS PROCESSING

Bringing together the perspectives of standard setters, users, and auditors/regulators allows us to make predictions about public company preparers ultimate behavior regarding the level of care and strategic bias associated with recognized and disclosed amounts. With respect to the level
of care, we expect that the views of standard setters, users, and auditors
will lead preparers to exhibit a higher standard of care (i.e., greater effort)
3 The literature in this area focuses on whether investors differential reaction to recognized
versus disclosed information reflects differences in perceived reliability or user cognitive processing differences. For example, using inferences from subsequent event reporting, Michels
[2013] concludes that differences in reactions to recognized versus disclosed information are
due to users failing to fully incorporate disclosed information into stock prices. In contrast,
Frederickson, Hodge, and Pratt [2006] find that investors perceived reliability differs between
recognition and disclosure. Additionally, Bratten, Choudhary, and Schipper [2013] find that
investors and creditors do not distinguish between recognition and disclosure for lease information with similar reliability. To date, the literature appears to suggest that both reliability
and cognitive processing differences have a role in the differential weighting of recognized
versus disclosed information, but has not fully explored the circumstances under which one
or the other force will prevail.

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

679

in their approach to determining recognized versus disclosed information


due to both the greater perceived importance and greater scrutiny that
recognized information receives relative to disclosed information. Again,
we represent this expectation in figure 1 with plus signs to indicate that the
level of care will be greater for recognition than for disclosure, as formally
stated in H1a below:
H1a: Public company preparers cognitive effort to arrive at a contingent liability estimate will be higher for recognition than for disclosure.
With respect to the strategic bias that preparers exhibit, the greater
scrutiny that standard setters and auditors apply to recognized information makes it less likely that preparers will attempt to strategically bias recognized information relative to disclosed information. We represent this
expectation with minus signs in figure 1. However, the fact that users place
greater weight on recognized information when making investment decisions suggests that preparers will have a greater incentive to strategically
bias recognized information to make the firm look more favorable, as represented by a plus sign in figure 1. To make a prediction about how preparers will resolve this conflict, we rely on recent research that suggests
that in a post-SOX environment preparers are likely to be more concerned
with auditor and regulator scrutiny than with impressing investors (e.g.,
Graham, Harvey, and Rajgopal [2005, p. 36], Cohen, Dey, and Lys [2008],
Agoglia, Doupnik, and Tsakumis [2011]). We express this in figure 1 by using thicker arrows to connect auditors/regulators to preparers. Therefore,
combining all forces together, we expect that preparers recognized estimates will exhibit less strategic bias than will their disclosed estimates, as
stated in H1b:
H1b: Pubic company preparers contingent liability estimates will be
less biased under recognition than disclosure.
If it is indeed the case that differences in the level of care and strategic
bias that preparers exhibit for recognized versus disclosed information are
driven by participation in the capital markets, then we would expect that
private company preparers would be less likely to exhibit these differences.
To test our theory, we turn our attention to private company preparers as a
comparison group.

2.4

COMPARING PUBLIC AND PRIVATE PREPARERS TO ASSESS EFFECTS OF


CAPITAL MARKET FORCES

To provide further insight on capital market forces as the source of differences in recognized versus disclosed estimates for public companies, we
propose private company preparers as a useful comparison. Private company preparers possess a similar level of training and business/financial reporting experience, but do not routinely confront stock market pressures

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S. M. CLOR-PROELL AND L. A. MAINES

in financial reporting. Limited prior research has considered how the absence of capital market pressures will affect the level of care and strategic bias that private company preparers exhibit for recognized, postaudit
information.4 In contrast, our research focuses on preaudit information
that is both recognized and disclosed.
Drawing on figure 1, we argue that the absence of capital market forces
will make private company preparers less sensitive to investors perspectives on financial information because private company investors typically
have greater familiarity with the company and are less likely than public
company investors to make investment decisions based on external financial reports. Thus, users greater emphasis on recognized information for
public companies is less likely to impact private companies. In turn, this
implies that auditors will have less reason to differentially scrutinize recognized information relative to disclosed information. Accordingly, we expect
that private company preparers will be more likely to exhibit a more similar level of care for recognized and disclosed information and will have
less incentive to bias recognized information relative to disclosed information. Thus, we predict that any differences observed for public company
preparers (the focus of H1a and H1b) will be weaker for private company
preparers, as formally stated in H2a and H2b below:
H2a: The difference in cognitive effort to arrive at a recognized versus
a disclosed contingent liability estimate will be greater for public
company preparers than for private company preparers.
H2b: The difference in strategic bias associated with a recognized versus a disclosed contingent liability estimate will be greater for
public company preparers than for private company preparers.
As shown in figure 1, the level of care and amount of strategic bias that
preparers exhibit should affect the liability estimate that they ultimately
report in the financial statements. Thus, for both public and private company preparers, we expect that these variables will mediate the relationship
between placement (recognition vs. disclosure) and preparers liability estimate. We state this formally in H3a and H3b below:

4 Prior literature has established the importance of various recognized metrics to preparers,
but has not examined how preparers think about recognized information relative to disclosed
information (Graham, Harvey, and Rajgopal [2005]). With respect to recognized information,
researchers have established two perspectives on this issue. The demand hypothesis argues
that private companies face fewer stakeholder demands and regulatory requirements to provide high-quality financial information to financial statement users than do public companies,
which leads private company preparers to be less concerned with the level of care for recognized information relative to public company preparers. Alternatively, the opportunistic
hypothesis argues that stakeholders reliance on financial information to make investment
and other decisions gives public company preparers a stronger incentive to bias recognized
information in ways favorable to the company (Givoly, Hayn, and Katz [2010], Hope, Thomas,
and Vyas [2013]). We argue that placement of information affects the relative strength of these
two hypotheses.

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681

H3a: Preparers cognitive effort will mediate the effect of placement


on their preaudit contingent liability estimates.
H3b: Preparers strategic bias will mediate the effect of placement on
their preaudit contingent liability estimates.5
Recall that the FASB identifies three elements of reliable information:
freedom from error, unbiasedness, and representing what it purports to
represent. We use preparers cognitive effort and level of strategic bias as
proxy measures for the first two elements. In our context, the third element corresponds to the extent to which the liability estimate in the financial statements reflects the ultimate cash outflow associated with the liability. The preceding discussion suggests that preparers liability estimates are
most likely to correspond to their beliefs about the ultimate cash outflow
when the estimate is recognized rather than disclosed. Further, we argue
that any potential difference will be smaller for private company preparers
than for public company preparers. Thus, our final hypothesis addresses
this third element of reliability and predicts that the difference between
preparers estimates and their expectation of the ultimate settlement of
the liability will be smaller for recognition than for disclosure, and that
differences between recognition and disclosure will be smaller for private
company preparers, as stated in H4 below:
H4: Preparers contingent liability estimates will be more closely associated with their beliefs about the ultimate liability settlement under recognition than under disclosure, and this difference will be
smaller for private company preparers than for public company
preparers.
In summary, we expect that public company preparers participation in
the stock market will affect the level of care and the amount of bias that
they exhibit when estimating financial information, with the level of care
being greater (H1a) and the amount of strategic bias being smaller (H1b)
for recognized information than for disclosed information. We also expect
that removing concerns about capital market pressures creates a benchmark to assess the effect of these pressures, with private company preparers exhibiting smaller effort- and bias-related differences under recognition versus disclosure than do public company preparers (H2a and H2b).
Further, we expect that preparers effort and bias will mediate their liability estimates (H3a and H3b). Finally, we expect that preparers liability
estimates will be more closely aligned with their beliefs about the ultimate
cash outflow if recognized than if disclosed and that this difference will be

5 Note, however, that the relation hypothesized in H3b may be somewhat mechanical as any
type of bias will have a direct impact on preparers estimates. We alleviate this direct impact in
our tests of H3b by using an indicator variable rather than a parametric variable to measure
bias.

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more pronounced for public company preparers than for private company
preparers (H4).

3. Method
3.1

PARTICIPANTS

We recruit participants for our experiment in two ways. First, we randomly select from alumni databases 670 practitioners with job titles that
identify them as either CFOs or controllers. Second, we randomly select
from the Capital IQ database 600 practitioners with job titles that identify
them as controllers. Practitioners are contacted via email or U.S. mail and
asked to participate in a Web-based experiment. In exchange for participation, we donate $10 to a not-for-profit on their behalf. A total of 113
practitioners (9%) participate in the experiment.6 Participants are 47 years
old on average, have an average of 24 years of business experience, and are
predominately male (82%). Sixty-nine percent hold a Certified Public Accountant license, and 83% list their job title as CFO and/or controller. One
hundred four participants (92%) indicate having experience with making
accounting estimates and accounting for contingent liabilities.7

3.2

DESIGN

Our experiment has a 2 2 + 1 between-subjects design.8 The 2 2


portion of the design is set in an external financial reporting context and
allows us to test our first three hypotheses. Participants in the 2 (company
trading status) 2 (placement) portion of the experiment are identified
as currently being associated with a public or private company (a measured
variable), and are randomly assigned to one of the two experimental conditions for placement of the contingent liability (a manipulated variable).
In the recognition (disclosure) condition, participants are told that the relevant accounting standard requires recognition (disclosure) of contingent
liabilities that have a moderate likelihood of being incurred and can be
reasonably estimated. The +1 portion of the design is set in an internal
6 Our response rate of 9% is similar to rates reported by surveys of financial executives,
including Graham, Harvey, and Rajgopal [2005] with a response rate of 10.4%.
7 The descriptive statistics for our participants are similar to those reported by prior research
that examines the judgments of experienced financial managers. For example, Bhojraj and
Libby [2005] report that their participants had 16 years of business experience and 59% were
CPAs. Similarly, Hunton, Libby, and Mazza [2006] report that their participants had 23 years
of business experience and 50% were CPAs.
8 We also manipulated the attainability of analysts forecasts on a between-subjects basis.
However, this manipulation was not a significant predictor of any of our dependent measures,
except for a marginally significant main effect on preparers liability estimates (F1,86 = 3.26, p
= 0.07). Moreover, this variable did not interact with other manipulated or measured variables
in any of our analyses (all F1,86 < 0.63, all p > 0.43). Finally, fully crossing this variable with
our other independent variables does not affect any of the inferences that we draw from our
analyses. Therefore, we do not discuss it further.

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683

reporting context in which there is no mention of relevant accounting standards. This condition provides a measure of preparers beliefs about the ultimate cash outflow associated with the liability estimate, thereby allowing
us to test H4.

3.3

MATERIALS AND PROCEDURE

The experiment is administered via a Web-based instrument. The task


requires participants to evaluate information about XYZ Corporation, a fictional public company in the electronic manufacturing services (EMS) industry.9 The company has recently become aware of a situation that may
result in a contingent liability for potential costs associated with the use of
a chemical in the firms manufacturing process. Participants in the 2 2
portion of the design assume the role of controller and estimate an amount
associated with the contingent liability for financial reporting purposes.
Participants in the +1 portion of the design assume the role of corporate
treasurer and provide, for internal planning purposes, their best estimate
of the amount that the company will ultimately have to pay in connection
with the liability.
The first part of the instrument provides participants with background information for XYZ Corporation and financial information, which includes
abbreviated balance sheets, income statements, and cash flow statements.
All financial information is constructed based on a composite of three actual firms in the EMS industry. Participants in the 2 2 portion also receive
information about executive compensation for the companys officers, and
information about analyst coverage and estimates.10 Next, all participants
receive information about the circumstances that have given rise to the possible contingent liability. Specifically, they are informed that XYZ Corporation has been using a chemical, CNX, in its manufacturing process, which
has potentially deleterious health effects. Some employees have been diagnosed with conditions, such as bronchitis, pneumonia, pulmonary edema
9 Note that the company in question is a publicly traded company. We test the effects of public versus private companies by identifying the type of company with which our participants
are associated, rather than by varying the type of company in the experimental materials. Consistent with discussion in Libby, Bloomfield, and Nelson [2002], we believe that professional
participants come to the experiment with experience in their particular professional setting
that is the primary determinant of how they approach the task. We are interested in the effect
of this experience in light of our manipulated variable.
10 Both public and private company participants may consider contracting or regulatory arrangements when completing the task. Thus, we designed characteristics of the company to
minimize the potential effects of these considerations on participants estimates. The amount
of long-term liabilities was minimal (4.7% of assets), suggesting that contracting issues related
to debt covenants were not likely to be material. In addition, while compensation was based
in part on bonuses related to financial information, no specific details were provided in the
materials about the exact nature or parameters of the compensation contracts. Finally, income
tax (regulatory) issues are not relevant because any deduction related to the contingent liability would be based on eventual cash outflows related to legal settlements, not on the estimated
amounts in the financial statements.

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S. M. CLOR-PROELL AND L. A. MAINES

(inflammation), and pulmonary fibrosis (scarring). Employees have required long-term therapy, have been unable to return to work, and have
filed claims and lawsuits for damages.
Following the contingent liability information, participants in the 2
2 portion are provided with the relevant accounting guidance, which
includes the placement manipulation, shown in the appendix. We make
three design choices with respect to the relevant accounting guidance. First,
we inform participants that they should adhere to the financial reporting
standard described in the case even if it does not conform to the guidance
that they are familiar with in their daily lives. Second, consistent with prior
research in accounting, we create a fictitious accounting standard that is
close, but not identical, to current accounting guidance governing contingent liabilities to ensure the scenario is familiar to participants but not
one for which they possess an automatic response (e.g., Cuccia, Hackenbrack, and Nelson [1995]). Third, the accounting guidance in the case is
silent with respect to the amount that should be accrued or disclosed when
there are a range of possible outcomes (i.e., FIN 14 guidance, FASB [1976],
now included in ASC 450, FASB [2013a]). This abstraction from current accounting standards is a critical design choice, which allows us to examine
how managers will strategically bias financial information when allowed to
do so. To the extent that our participants are familiar with FIN 14 guidance,
this biases against our ability to observe treatment effects.
Participants are instructed to assume that any insurance coverage related
to the potential liability will be accounted for separately. Participants in
the 2 2 portion also receive information about the companys materiality
threshold ($4.5 million). All participants then receive additional information about the estimated number of affected employees and are provided
with three approaches that can be used to estimate the liability. Participants
access each approach by clicking on a link, which brings up a textbox. Participants must close the textbox before continuing with the instrument, allowing us to track the amount of time that participants spend viewing each
approach.
The approaches increase in the effort required to calculate the minimum and maximum for the range of potential costs associated with
consequences of the chemical. Specifically, Approach One requires participants to perform two multiplications; Approach Two requires six multiplications and two additions with each addition involving three numbers;
Approach Three requires 18 multiplications and 2 additions with each addition involving nine numbers. See the appendix for a description of the
three approaches.
The three approaches also result in different estimates for ranges of
possible costs. Approach One provides an estimate range from approximately $858,600$14,166,900, Approach Two has an approximate range
of $3,847,000$15,315,000, and Approach Three provides a range of
$6,709,000$15,291,500. The midpoint of the range increases with the effort required ($7,512,750, $9,581,000, and $11,000,250 for low, medium,

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

685

and high effort, respectively). Moreover, the range decreases as the effort associated with the approach increases ($13,308,300, $11,468,000,
and $8,582,500 for low, medium, and high effort, respectively), suggesting greater precision of the estimate. Thus, Approach Three appeared the
most valid in that it used the most disaggregated information to arrive at an
estimate.11
After accessing the approaches and completing their calculations, participants respond to the questions that elicit the dependent variables and
are able to scroll through all information provided thus far. After submitting this section of the instrument, all participants are directed to a second
question set and are not allowed to return to this portion of the experiment. The second question set contains manipulation check questions, debriefing questions, and demographic questions. Submitting this section of
the instrument completes the experiment.

3.4

DEPENDENT VARIABLES

We use three dependent variables to test our hypotheses. The first dependent variable is participants estimate for the contingent liability. Participants in the 2 2 portion are asked the following, Given the contingent
liability information and accounting guidance stated in the case, please estimate the amount of the contingent liability that XYZ Co. should accrue
[disclose] in the 20x4 balance sheet [footnotes] in connection with the use
of CNX. Participants in the +1 portion are asked, Given the contingent
liability information, please provide your best estimate of the amount the
company will have to pay related to CNX.
The second dependent variable, designed to capture the effort that participants bring to the task, is based on participants response to the following, Please explain how you arrived at your liability estimate in the first
question above. Please indicate how, if at all, you incorporated the three
approaches described above. As described more fully in section 4, all responses are coded by two independent coders to form a measure of preparers effort.
The third dependent variable is a measure of the bias associated with
participants contingent liability estimate. After providing their estimate,
participants are asked to provide a 90% confidence interval for the actual
amount that the company will have to pay for the liability. To determine
whether participants estimates for the contingent liability are biased, we

11 The experienced accountants that we consulted in developing the experimental materials suggested that, while all approaches seem acceptable, the face validity of the approaches
increases with their complexity. Moreover, as part of a post-experimental questionnaire, we
also asked a subset of our participants (those from the Capital IQ database) to rank the three
methods in terms of perceived reliability. Their ranking mirrored the effort associated with
the approach, with the high-effort Approach Three ranked first, the medium-effort Approach
Two ranked second, and the low-effort Approach One ranked third in perceived reliability.

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S. M. CLOR-PROELL AND L. A. MAINES

compare each participants liability estimate to the midpoint of his/her


confidence interval. If the liability estimate is less than (equal to) [greater
than] the midpoint, then the bias measure takes a value of 1 (0) [+1].
If a participants estimate is equal to the midpoint of his/her confidence
interval, then we argue that the estimate is unbiased. If, however, participants choose an estimate that is either greater or less than the midpoint of
their range for the eventual costs that the company will incur to resolve the
liability, then we argue that the estimate is biased.
We acknowledge two weaknesses of the bias dependent variable. First, deviations from the midpoint of the range may simply reflect that participants
have a nonuniform probability distribution for values within the range.
Thus, these deviations may not be intentional bias. Second, we acknowledge that a participant who chooses to report a biased point estimate may
also choose to report a confidence interval that is similarly biased. However,
it is important to note that if the point estimate and the confidence interval are both biased in the same direction, then our bias measure is more
likely to take a value of zero, which would suggest no bias even in circumstances in which bias exists. Thus, we view our bias measure as providing a
conservative test of the bias associated with preparers estimates.

4. Results
4.1

MANIPULATION CHECK

Of the 94 participants in the 2 2 external financial reporting conditions, 85% (94%) of participants in the recognition (disclosure) conditions
correctly indicated that the accounting guidance in the case requires contingent liabilities with a moderate likelihood of being incurred to be accrued in the balance sheet (disclosed in the footnotes). We find that company trading status does not have either a main or interactive effect on the
placement manipulation check (all F1,87 < 0.86, all p > 0.35), indicating
that both groups of participants responded similarly to the manipulation.
Further, there were no main or interactive effects associated with participants interpretation of the term moderate likelihood used in the accounting guidance (all F1,80 < 0.39, all p > 0.53), indicating that all participants interpreted the threshold necessary for recognition (disclosure) in a
similar manner. Thus, we deem the placement manipulation to be successful. Further, excluding the participants who failed the placement manipulation check question does not affect the results. Therefore, all analyses
include these participants.

4.2

HYPOTHESIS TESTS

We examine how preparers influence the reliability of preaudit estimates


by assessing the level of care and the amount of strategic bias that preparers
bring to the task when estimating a contingent liability. Further, we examine how the resulting estimate compares to preparers beliefs about the

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

687

ultimate cash outflow associated with the liability. We structure our hypothesis tests by first examining the hypotheses that relate to preparers level
of care, then examining the hypotheses that relate to the amount of strategic bias, and finally examining the hypothesis that compares the liability
estimate to preparers beliefs about future cash outflows for the liability.
4.2.1. Examining Preparers Level of Care. H1a, H2a, and H3a all relate to
the level of care that preparers exhibit with respect to financial information. H1a predicts that public company preparers will expend greater cognitive effort when estimating recognized amounts than when estimating
disclosed amounts. To test this hypothesis, we examine the process data collected in the experiment. Specifically, participants were asked to describe
the process they used to make their judgment and to describe how they
incorporated the three approaches shown in the appendix. As discussed in
section 3, the approaches require an increasing amount of effort to implement, and therefore serve as a measure of cognitive effort.
Participants open-ended responses were separately coded by an author
and a research assistant, both blind to condition. Responses were coded on
a zero-to-three scale, with higher numbers indicating that the participant
used a more effortful judgment approach. That is, responses were coded as
zero for participants who did not use any of the approaches when making
their judgments. For participants who used one or more of the approaches
when making their judgments, responses were coded as one if the most effortful approach stated in the response was Approach One, coded as two
if the most effortful approach stated in the response was Approach Two,
and coded as three if the most effortful approach stated in the response
was Approach Three. Scores assigned by each coder were highly correlated
(r90 = 0.87, p < 0.01) and all disagreements between coders were resolved
by a separate author, also blind to condition, to create a consensus process code for each participant. Inferences are identical if based on either
coders individual codes.
We report the descriptive statistics associated with the consensus process code in table 1, panel A.12 We test H1a by examining the simple effect of placement on the public company managers process codes. As
reported in table 1, panel C, we find that the average consensus process
code is significantly greater under recognition (2.65) than under disclosure (2.00) (F1,88 = 5.46, p = 0.02).13 This pattern of results is consistent
with H1a, indicating that public company preparers expend more cognitive
effort when estimating recognized amounts than when estimating disclosed
amounts.

12 This analysis is based on 92 of the 94 participants because two participants had responses
that were incomplete.
13 Throughout the paper, we report least square means that adjust for unbalanced cell sizes.
The degrees of freedom vary for different tests due to a few participants not responding to all
questions. All p-values reported in the paper are two-tailed for the sake of consistency.

688

S. M. CLOR-PROELL AND L. A. MAINES


TABLE 1
Process Data

Panel A: Process code descriptive statistics: Least square mean [median] (standard deviation)
Placement Condition
Public company participants

Private company participants

Recognition

Disclosure

2.65
[3.00]
(0.80)
n = 26
2.67
[3.00]
(0.58)
n = 21

2.00
[3.00]
(1.24)
n = 18
2.48
[3.00]
(0.98)
n = 27

Panel B: Conventional ANOVA and results of planned contrast


Source

df

MS

F-Statistic

p-Value

Placement
Trading status
Placement trading status
Error
Planned contrast (H2a)
Residual

1
1
1
88
1
2

3.94
1.37
1.23
0.83
5.51
0.08

4.73
1.64
1.48

0.03
0.20
0.23

6.61
0.09

0.01
0.91

Panel C: Simple effects tests


Conditions Compared

df

F-Statistic

p-Value
(Two-Tailed)

Recognition versus disclosure for public participants (H1a)


Recognition versus disclosure for private participants
Public versus private participants under recognition
Public versus private participants under disclosure

1
1
1
1

5.46
0.49
0.00
3.01

0.02
0.49
0.96
0.09

Panel D: Percentage of time spent on each judgment approach


Public Company
Participants
Recognition
Percentage of time spent
on Approach One
Percentage of time spent
on Approach Two
Percentage of time spent
on Approach Three

Private Company
Participants

Disclosure

Recognition

19.55%

23.81%

23.68%

>

Disclosure
16.42%

21.86%

<

30.00%

31.66%

33.52%

58.59%

>

46.18%

44.66%

50.06%

Participants described the process they used to estimate a dollar amount for a contingent liability that
was either to be recognized (recognition condition) or disclosed (disclosure condition) in the financial
statements. Participants were employed by either a publicly traded or privately held company. Participants
self-described process was coded by two coders that were blind to treatment condition and then differences
were resolved to create a consensus process code. Responses were coded on a zero-to-three scale and higher
numbers indicate a more effortful judgment process. Panel A reports the descriptive statistics. Panel B
reports the conventional analysis of variance and the results of the planned contrast. Panel C presents
the simple effects tests. Panel D reports the percentage of time that participants spent on each judgment
approach provided in the case, as tracked by the computer software used to administer the experiment.
Approach One requires the least effort to implement and Approach Three requires the most effort to
implement.

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

689

H2a predicts that public company preparers will exhibit greater differences in cognitive effort between recognition and disclosure than will private company preparers. The weights embedded in the traditional ANOVA
interaction, however, differ from the weights inherent in our hypothesized
interaction, suggesting that a contrast test is more appropriate (Buckless
and Ravenscroft [1990]). Using the approach recommended by Buckless
and Ravenscroft [1990], we derive contrast weights of +2 (recognitionprivate), +2 (recognition-public), +1 (disclosure-private), 5 (disclosurepublic). These weights reflect our expectation that differences in cognitive
effort will be greater for public company preparers (+2 vs. 5) than for
private company preparers (+2 vs. +1).
Table 1, panel B presents the contrast test. We find that our hypothesized
interaction is significant (F1,88 = 6.61, p = 0.01).14 Examining the remaining simple effects tests reported in table 1, panel C, we find that the private
company preparers use a similar judgment process regardless of whether
they are in the recognition or disclosure condition (F1,88 = 0.49, p = 0.49).
Further, we find that there is not a significant difference between public
and private company preparers judgment process in the recognition condition (F1,88 = 0.00, p = 0.96). In contrast, we find that there is a marginally
significant difference between public and private company preparers judgment process in the disclosure condition (F1,88 = 3.01, p = 0.09). These
results are consistent with H2a.15
H3a predicts that preparers effort levels will mediate their preaudit estimates of the contingent liability. To test H3a, we use a four-step procedure that examines the links shown in figure 2 for the consensus process
code as a mediator of the liability estimate (Baron and Kenny [1986],
Kenny, Kashy, and Bolger [1998]). The first step in this procedure requires that we establish a significant relationship between our independent variables and participants liability estimates. Using the same contrast
weights that we used to test H2a, we find that this relationship is significant
14 Our results are robust to alternative contrast weights, including weights that predict
no difference between recognition and disclosure for private company managers. For example, alternative weights of +1 (recognition-private), +1 (recognition-public), +1 (disclosureprivate), 3 (disclosure-public) yield a significant interaction (F1,88 = 6.26, p = 0.01). Similarly, weights of +2 (recognition-private), +2 (recognition-public), 1 (disclosure-private),
3 (disclosure-public) yield a significant interaction (F1,88 = 6.35, p = 0.01). Further, we examine the residual between-group variance that is not captured by the planned contrast, and
we find that it is insignificant (F2,88 = 0.09, p = 0.91). This indicates that the specified contrast
weights are a good fit for the data.
15 To shed light on whether the differences in preparers effort levels were intentional, our
post-experimental questionnaire included a within-participants question about how effort levels would be affected by recognition versus disclosure. We find that responses to this question
did not differ for the public and private company participants (F1,89 = 0.44, p = 0.51), with
both groups indicating that they expected to exert slightly more effort under recognition than
under disclosure. This result is consistent with the direction of the relative mean process codes
for recognition versus disclosure for both public and private company participants in table 1,
panel A.

690

S. M. CLOR-PROELL AND L. A. MAINES

Judgment Process
(Process Code)

Link 2
F1,88 = 6.61, p = 0.01

Placement x
Trading Status
Contrast

Link 3
F1,90 = 34.82, p < 0.01

Link 1
F1,90 = 8.56, p < 0.01
Link 4
(with mediator)
F1,87 = 2.72, p = 0.10

Contingent
Liability Estimate

FIG. 2.Mediation analysis with cognitive effort as mediator. This figure depicts the mediation
analyses conducted as a test of H3a using a four-step procedure (Baron and Kenny [1986],
Kenny, Kashy, and Bolger [1998]). The analyses estimate the direct path from the independent variable to the dependent variable (link 1) and the indirect path from the independent
variable to the dependent variable via the mediator (links 2 and 3). Finally, the analyses estimate the effect of the independent variable on the dependent variable in the presence of the
mediator (link 4). This figure shows that the effects of placement and trading status on participants contingent liability estimate are mediated by participants self-reported judgment
process (process code).

(F1,90 = 8.56, p < 0.01; link 1). As reported in connection with our tests
of H2a, the placement by trading status interaction significantly predicts
preparers consensus process codes (F1,88 = 6.61, p = 0.01; link 2). Next,
we find that participants process codes significantly predict their liability
estimates (F1,90 = 34.82, p < 0.01; link 3). Finally, we find that the effect of
placement and trading status on participants liability estimates is insignificant (F1,87 = 2.72, p = 0.10) in the presence of the process code, and that
the process code remains significant (F1,87 = 28.01, p < 0.01; link 4). Thus,
consistent with H3a, we conclude that participants self-described judgment
process mediates their contingent liability estimates.
4.2.2. Examining Preparers Strategic Bias. H1b, H2b, and H3b all relate
to the amount of strategic bias that preparers exhibit with respect to financial information. H1b predicts that public company preparers liability
estimates will be less biased under recognition than disclosure. To test this
hypothesis, we examine the simple effect of placement on our measure of
bias for public company managers. Recall that our bias measure takes a
value of 1 (0) [+1] if a participants liability estimate is less than (equal
to) [greater than] the midpoint of the participants range. The means reported in table 2, panel A reveal that public company managers disclosed
liability estimates are downwardly biased relative to their recognized estimates (0.58 vs. 0.08). As reported in table 2, panel C, we find that this
difference is significant (F1,90 = 6.83, p = 0.01). Again, this pattern of

691

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE


TABLE 2
Bias Measure
Panel A: Bias descriptive statistics: Least square mean [median] (standard deviation)
Placement Condition
Public company participants

Private company participants

Recognition

Disclosure

0.08
[0.00]
(0.89)
n = 26
0.32
[0.50]
(0.78)
n = 22

0.58
[1.00]
(0.61)
n = 19
0.04
[0.00]
(0.94)
n = 27

Panel B: Conventional ANOVA and results of planned contrast


Source

df

MS

F-Statistic

p-Value

Placement
Trading status
Placement trading status
Error
Planned contrast (H2b)
Residual

1
1
1
90
1
2

0.52
0.28
5.89
0.69
3.55
1.42

0.75
0.41
8.52

0.39
0.53
< 0.01

5.14
2.06

0.03
0.13

Panel C: Simple effects tests


Conditions compared

df

F-Statistic

p-Value
(Two-Tailed)

Recognition versus disclosure for public participants (H1b)


Recognition versus disclosure for private participants
Public versus private participants under recognition
Public versus private participants under disclosure

1
1
1
1

6.83
2.21
2.69
6.12

0.01
0.14
0.10
0.02

Participants provided a dollar estimate for a contingent liability that was either to be recognized (recognition condition) or disclosed (disclosure condition) in the financial statements, as well as a 90% confidence interval for the ultimate payout. We construct a three-level bias measure by comparing participants
liability estimate to the midpoint of their confidence interval. A liability estimate that is less than (equal to)
[greater than] the participants midpoint is coded as 1 (0) [+1]. Participants were employed by either a
publicly traded or privately held company. Panel A reports the descriptive statistics. Panel B presents the
conventional analysis of variance and the results of the planned contrast. Panel C presents the simple effects
tests.

results is consistent with H1b, suggesting that public company preparers


recognized estimates are less biased than their disclosed estimates.
H2b predicts that public company preparers will exhibit greater differences in strategic bias between recognition and disclosure than will private company preparers. As was the case with H2a above, we use contrast weights of +2 (recognition-private), +2 (recognition-public), +1
(disclosure-private), 5 (disclosure-public) to test this hypothesis. Again,
these weights reflect our expectation that differences in strategic bias will
be greater for public company preparers (+2 vs. 5) than for private company preparers (+2 vs. +1).

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S. M. CLOR-PROELL AND L. A. MAINES

Table 2, panel B presents the contrast test. We find that our hypothesized
interaction is significant (F1,90 = 5.14, p = 0.03).16 Examining the remaining simple effects tests reported in table 2, panel C, we find that the bias
measure for private company preparers does not differ between recognition and disclosure (F1,90 = 2.21, p = 0.14). Further, comparing the bias
measure for public company preparers to that of private company preparers, we find that there is not a significant difference between public and
private company preparers in the recognition condition (F1,90 = 2.69, p
= 0.10). However, in the disclosure condition public company preparers
exhibit a significant downward bias when compared to private company
preparers (F1,90 = 6.12, p = 0.02). Thus, we find a pattern of results that is
consistent with H2b.
H3b predicts that preparers strategic bias will mediate their preaudit
estimates of the contingent liability. To test H3b, we again use a four-step
procedure that examines the links shown in figure 3 for the bias measure as
a mediator of the liability estimate (Baron and Kenny [1986], Kenny, Kashy,
and Bolger [1998]). As was the case with our test of H3a, we find that link
1 is significant (F1,90 = 8.56, p < 0.01). As reported in connection with
our tests of H2b, the placement by trading status interaction significantly
predicts preparers bias measure (F1,90 = 5.14, p = 0.03; link 2). Next, we
find that participants bias measure significantly predicts their liability estimates (F1,92 = 48.73, p < 0.01; link 3). Finally, we find that the effects of
placement and trading status on participants liability estimates are less significant (F1,89 = 3.67, p = 0.06) in the presence of the bias measure, and
that the bias measure remains significant (F1,89 = 44.00, p < 0.01; link 4).
Thus, consistent with H3b, we conclude that participants bias measure also
partially mediates their contingent liability estimates.17
4.2.3. Comparing Preparers Estimates to Their Beliefs About Ultimate Cash Outflows. H4 predicts that preparers liability estimates will be more closely associated with their beliefs about ultimate cash outflows under recognition
16 Our results are robust to alternative contrast weights that predict no difference between
recognition and disclosure for private company managers. For example, alternative weights
of +1 (recognition-private), +1 (recognition-public), +1 (disclosure-private), 3 (disclosurepublic) yield a significant interaction (F1,90 = 5.71, p = 0.02). However, our results are not
robust to weights that predict a greater difference between recognition and disclosure for private company managers. For example, weights of +2 (recognition-private), +2 (recognitionpublic), 1 (disclosure-private), 3 (disclosure-public) do not yield a significant interaction
(F1,90 = 2.53, p = 0.12). We view this as being consistent with our expectation that the differences for private company managers are very small. Further, we examine the residual betweengroup variance that is not captured by the planned contrast, and we find that it is insignificant
(F2,90 = 2.06, p = 0.13).
17 If we include both the consensus process code and the bias measure in the model simultaneously, we find that both measures mediate the relationship between the independent and
dependent variables. That is, controlling for both measures, we find that the effects of placement and trading status on participants liability estimates are insignificant (F1,86 = 0.79, p =
0.38) and that both the consensus process code (F1,86 = 29.35, p < 0.01) and the bias measure
(F1,86 = 41.67, p < 0.01) remain significant.

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

693

Bias
Measure
Link 2
F1,90 = 5.14, p = 0.03

Placement x
Trading Status
Contrast

Link 3
F1,92 = 48.73, p < 0.01

Link 1
F1,90 = 8.56, p < 0.01
Link 4
(with mediator)
F1,89 = 3.67, p = 0.06

Contingent
Liability Estimate

FIG. 3.Mediation analysis with strategic bias as mediator. This figure depicts the mediation
analyses conducted using a four-step procedure (Baron and Kenny [1986], Kenny, Kashy, and
Bolger [1998]). The analyses estimate the direct path from the independent variable to the
dependent variable (link 1) and the indirect path from the independent variable to the dependent variable via the mediator (links 2 and 3). Finally, the analyses estimate the effect of
the independent variable on the dependent variable in the presence of the mediator (link 4).
This figure shows that the effects of placement and trading status on participants contingent
liability estimate are partially mediated by participants strategic bias.

than under disclosure, and that this difference will be smaller for private
company preparers than for public company preparers. To assess participants beliefs about the ultimate liability, we asked 19 participants in the +1
internal reporting condition to provide their best estimate of the amount
that the company will ultimately have to pay in connection with the liability.
Participants in this condition provided a mean estimate of $9,321,308 for
the contingent liability (untabulated).
To test H4, we subtract the mean in the internal reporting condition from
the responses of participants in the 2 2 external reporting conditions.
Table 3, panel A shows the descriptive statistics associated with both preparers liability estimates and the distance of these estimates from the average
response in the internal reporting condition. We expect the pattern of differences between preparers external estimates and beliefs to follow the
same pattern as we expected for preparers effort and bias measures. Thus,
we test H4 using the same contrast weights that we used to test H2a and
H2bi.e, weights of +2 (recognition-private), +2 (recognition-public), +1
(disclosure-private), 5 (disclosure-public). As shown in table 3, panel B,
we find that this contrast is significant (F1,90 = 8.56, p < 0.01) and that the
residual is not significant (F2,90 = 0.09, p = 0.92).18,19
18 Our results are robust alternative contrast weights of +1 (recognition-private), +1
(recognition-public), +1 (disclosure-private), 3 (disclosure-public) (F1,90 = 8.64, p < 0.01),
and alternative contrast weights of +2 (recognition-private), +2 (recognition-public), 1
(disclosure-private), 3 (disclosure-public) (F1,90 = 6.45, p = 0.01).
19 As an alternative approach to testing H4, we conduct a series of t-tests that compare each
of the external liability estimates to the internal reporting estimate. We find that only the

694

S. M. CLOR-PROELL AND L. A. MAINES


TABLE 3
Contingent Liability Estimates

Panel A: Descriptive statistics: Least square mean [median] (standard deviation)


External Reporting Estimate
Placement Condition
Public company participants

Private company participants

Distance from Internal


Reporting Estimate
Placement Condition

Recognition

Disclosure

Recognition

Disclosure

$8,232,191
[$9,473,000]
($4,144,765)
n = 26
$8,706,995
[$9,800,000]
($4,028,186)
n = 22

$5,205,624
[$7,500,000]
($4,568,828)
n = 19
$8,322,280
[$10,000,000]
($4,312,118)
n = 27

$1,089,117
[$151,692]
($4,144,765)
n = 26
$614,313
[$478,692]
($4,028,186)
n = 22

$4,115,684
[$1,821,308]
($4,568,828)
n = 19
$999,028
[$678,692]
($4,312,118)
n = 27

Panel B: Conventional ANOVA and results of planned contrast


Source

df

MS

F-Statistic

p-Value

Placement
Trading status
Placement trading status
Error
Planned contrast (H4)
Residual

1
1
1
90
1
2

6.70
7.43
4.02
0.18
1.55
0.01

3.70
4.10
2.22

0.06
0.05
0.14

8.56
0.09

<0.01
0.92

Panel C: Simple effects tests


Conditions Compared

df

F-Statistic

p-Value
(Two-Tailed)

Recognition versus disclosure for public participants


Recognition versus disclosure for private participants
Public versus private participants under recognition
Public versus private participants under disclosure

1
1
1
1

5.55
0.10
0.15
5.98

0.02
0.75
0.70
0.02

Participants provided a dollar estimate for a contingent liability that was either to be recognized (recognition condition) or disclosed (disclosure condition) in the financial statements. Participants were employed by either a publicly traded or privately held company. A separate group of participants provided an
estimate of the ultimate payout for internal reporting purposes. Panel A reports the descriptive statistics.
Panel B presents the effects of the conventional analysis of variance and the results of the planned contrast.
Panel C presents simple effects tests.

Simple effects tests reported in table 3, panel C reveal that the private
company preparers make similar estimates regardless of whether they are
in the recognition or disclosure condition (F1,90 = 0.10, p = 0.75). Further, we find that there is not a significant difference between public and
private company preparers estimates in the recognition condition (F1,90 =
0.15, p = 0.70). In contrast, we find that public company preparers make
liability estimate provided by public company participants in the disclosure condition differs
significantly from the internal reporting estimate (t36 = 2.42, p = 0.02). All other external
reporting means are not statistically different from the internal reporting mean (all t < 0.73,
all p > 0.46).

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

695

estimates that are closer to beliefs about cash outflow in the recognition
condition than in the disclosure condition (F1,90 = 5.55, p = 0.02). Finally,
we find that in the disclosure condition private company preparers estimates are closer to beliefs about ultimate cash outflows than are public
company preparers estimates (F1,90 = 5.98, p = 0.02). Thus, the data are
consistent with H4, and we conclude that preparers estimates in our setting are reasonably close to their beliefs about the ultimate cash outflow
for the liability, with the exception of public company preparers who make
estimates in the disclosure condition that are significantly lower than their
beliefs about the ultimate resolution of the liability.

4.3

ADDITIONAL ANALYSES

4.3.1. Supplemental Evidence of Processing Differences. To more closely examine the processing differences described above, and to provide convergent evidence with respect to participants self-reported judgment process, we also examine the time that participants spent on each approach
as a percentage of the total time spent using the approaches that we provided. Overall, participants spent approximately 9.8 minutes on the three
approaches provided in the experiment. We find that the total time spent
on the three approaches does not differ depending on whether participants
are from public or private companies (F1,92 = 0.23, p = 0.63; untabulated).
However, the way that participants allocated their time does differ across
firm type. The results of this analysis appear in table 1, panel D and reveal
that public company managers spent a greater percentage of their time
looking at Approach Three (the high-effort approach) in the recognition
condition than in the disclosure condition (58.59% vs. 46.18%; t43 = 2.12,
p = 0.04). Correspondingly, public company managers spent a greater percentage of their time on Approach Two (a medium-effort approach) in the
disclosure condition than in the recognition condition (30.00% vs. 21.86%,
t43 = 2.07, p = 0.04).
In contrast, we find that there are fewer processing differences for the
private company managers. Private company managers spent less time on
Approach One (the low-effort approach) in a disclosure setting relative to
a recognition setting (16.42% vs. 23.68%; t47 = 2.37, p = 0.02). However,
the percentage of time spent by managers in either condition on Approach
One is relatively small, suggesting that it did not have a substantial impact
on their estimates. We find no difference between the recognition and disclosure conditions in the percentage of time spent for either approaches
Two or Three, the two approaches where managers spent most of their
time. Thus, the computer-tracked data are consistent with participants selfreported data, indicating that public company managers exhibit less effortful processing in a disclosure setting than in a recognition setting, while
private company managers exhibit similar processing in both the recognition and disclosure settings.

696

S. M. CLOR-PROELL AND L. A. MAINES

4.3.2. Evidence Regarding Conservatism in Preparers Estimates. We assert


that private company preparers are a useful benchmark for assessing the
effects of capital market pressures on preparers liability estimates, and
we find that private company preparers recognize directionally higher liability estimates than do their public company counterparts. While table 3
suggests that private company preparers estimates are more reliable than
those of public company preparers because they are directionally closer
to estimates of ultimate cash outflows, it may be the case that the private
company preparers recognized higher liability estimates out of a desire to
be more conservative rather than to report a more reliable number. Thus,
we conduct an additional analysis to look for evidence of conservatism in
preparers estimates. Our analysis focuses on unconditional conservatism,
defined in the literature as recognizing the highest value for liabilities (e.g.,
Ball and Shivakumar [2005]). We do not address conditional conservatism,
defined as recognizing losses sooner than gains (e.g., Ball and Shivakumar
[2005]), because we examine only loss recognition.
If participants are exhibiting unconditional conservatism in their recognized numbers, we would expect their liability estimates to be above the
midpoint of their confidence interval for the ultimate cash outflow, that
is, their bias measure should equal 1 as measured in table 2. Thus, we examine whether the private company participants are more likely to have a
bias measure of 1 than are the public company participants. Looking just
at recognized estimates, we find that 18% (4/22) of private company preparers report a liability greater than their confidence interval midpoint,
compared to 42% (11/26) of public company preparers. Although this difference is not statistically significant ( 2 1,48 = 3.23, p = 0.20), it is in the
direction of private company preparers being less conservative than public
company preparers. Thus, our unconditional conservatism test provides no
evidence that private company preparers desire to be more conservative in
their judgments than do the public company preparers.

5. Discussion
In this paper, we investigate whether financial managers from publicly
traded and privately held companies differentiate between recognition and
disclosure when estimating a contingent liability. Drawing on Bernard and
Schipper [1994], we argue that participation in the stock market creates
pressures for public company managers that can affect the relative reliability of their recognized and disclosed estimates via both the level of care
and the amount of strategic bias that they exhibit. Thus, we draw on private
company preparers, who do not face stock market pressures, to provide a
comparison group against which we can assess the judgments of the public
company managers. Specifically, we compare both groups in terms of the
cognitive effort, and the amount of bias that they bring to the estimation
task. Further, we investigate how the resulting estimate compares to that
provided by preparers tasked with estimating the ultimate cash outflow for

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

697

internal reporting purposes (our proxy for preparers beliefs about the ultimate resolution of the liability).
Our results indicate that public company managers generally exhibit less
cognitive effort and more bias for disclosure than for recognition. We find
that these differences are smaller for private company managers. Further,
we find that both preparers level of care and amount of bias affect their
preaudit liability estimates. In addition, comparing preparers estimates to
those provided by preparers in an internal reporting setting reveals that
public company managers exhibit a downward bias in their disclosed estimates, but not in their recognized estimates. In contrast, private company managers do not exhibit a bias in either their disclosed or their recognized estimates. Additional analyses support our level of care results by
documenting that computer-tracked process data are consistent with participants self-reported judgment process. Further, examining preparers recognized estimates, we find no evidence to support the notion that higher
estimates result from a desire to be more conservative, lending credence to
the idea that these estimates are, in fact, more reliable.
Our findings add to the relatively sparse literature on preparers judgments and decisions (Bhojraj and Libby [2005], Hunton, Libby, and Mazza
[2006]). Stock market pressures play a primary role in both the amount
of cognitive effort that preparers are willing to devote to the reporting
task, and the extent to which preparers are willing to bias their financial
estimates, thereby leading to the differential reliability of preparers recognized and disclosed estimates. For public company managers, our results support users assumption that recognized numbers are more reliable
than disclosed numbers. This result, along with those of Libby, Nelson, and
Hunton [2006], also indicates that decisions of managers and auditors work
in conjunction to lead to greater reliability of recognized versus disclosed
numbers. Thus, it is particularly important for auditing regulators to clarify
auditors responsibilities with respect to disclosed information.
We believe that our results provide some interesting avenues for future
research. For example, additional research opportunities emerge when
contrasting our results with other studies on recognition/disclosure. First,
our study involved estimating an item that is likely to eventually be recognized in income. That is, even in the disclosure condition, preparers may
have been conscious that the amount would eventually be recognized as
an expense. We believe that this design choice increases the tension in our
tests and biases away from us finding results. However, it also means that
our study differs from prior studies on recognition versus disclosure that
examined stock-based compensation, in which the disclosure choice had
no implications for future expenses. Thus, future research could examine
how the bias and decreased effort that we observed in our disclosure setting
would be affected if the required disclosure was not expected to affect net
income in the future.
Second, we assessed the reliability of preparers estimates using three
metrics that we believe capture the FASBs conceptual definition of

698

S. M. CLOR-PROELL AND L. A. MAINES

reliability as information that is free from error, unbiased, and represents what it purports to represent. Namely, we captured preparers effort,
amount of bias, and underlying beliefs about the contingent liability. However, we also note that reliability is a difficult and elusive concept to measure (Maines and Wahlen [2006]). Thus, future research could consider
additional ways in which our metrics, or other metrics, could be refined to
better examine the reliability of preparers estimates.
Third, we examined preparers estimates under conditions of mandated,
rather than voluntary, recognition versus disclosure. We believe that this is
an important design choice that helps us avoid self-selection issues and is
consistent with most real-world settings in which an actual choice between
recognition and disclosure is unlikely (Schipper [2007]). That being said,
future research could examine questions such as how the choice to make a
disclosure, for example, affects the care with which preparers attend to the
task. Namely, preparers who choose to disclose information may dedicate
more effort to the task than preparers who are required to disclose information. In short, we leave it to further research to examine these and other
factors that may affect preparers recognition and disclosure decisions.
APPENDIX

Excerpts from Experimental Instrument


ACCOUNTING GUIDANCE

Based on the information above, you think that there is a moderate


likelihood that a liability has been incurred. You also consulted with
the companys attorneys, who agreed with your assessment that there
is a moderate likelihood that a liability has been incurred. You have
sought guidance from financial accounting standards about the appropriate accounting treatment for this potential liability. You have found the
following:
Financial accounting standards require the accrual of a liability on the
balance sheet (disclosure of a liability in the footnotes but no accrual in the balance
sheet) if it is moderately likely that a liability has been incurred at the date
of the financial statements and the amount of the loss can be reasonably
estimated.
APPROACH INFORMATION

The vice president of manufacturing has conducted a comprehensive review of the manufacturing process and has estimated that roughly 2% of
the 7,942 manufacturing employees work directly with CNX and potentially
have been affected by their exposure.
There are a number of possible approaches that can be used to estimate
the liability. You have identified three approaches: the first approach estimates the liability based on the expected average claim, the second estimates claims by potential size, and the third estimates claims by potential

THE IMPACT OF RECOGNITION VERSUS DISCLOSURE

699

size and geographical region. The links below provide the details associated
with each approach.
Approach One. Details: This approach estimates the liability based on the
size of the average potential claim.
Implementation: Implementing the approach requires multiplying the
estimated average claim by number of potentially affected employees. Recall that the total number of potentially affected employees is 7,942 2% =
159.
Additional information: The average claim per manufacturing employee
is estimated to be between $5,400 and $89,100.
Approach Two. Details: This approach estimates the liability based on the
size of potential claims and the proportion of affected employees that are
expected to have claims of a given size.
Implementation: Implementing the approach requires determining the
number of potentially affected employees that could have small, medium,
and large claims. Then it requires multiplying the number of potentially
affected employees by the corresponding claim size. Recall that the total
number of potentially affected employees is 7,942 2% = 159.
Additional information:
Small potential claims:
$1,000$5,000 per employee
87 potentially affected employees
Mid-sized potential claims:
$10,000$80,000 per employee
56 potentially affected employees
Large potential claims:
$200,000$650,000 per employee
16 potentially affected employees
Approach Three. Details: This approach estimates the liability based on
the size of potential claims and the proportion of affected employees that
are expected to have claims of a given size. It also takes into account the
geographic region in which the affected employees are located and the
effect that this will have on the possible payouts.
Implementation: Implementing the approach requires determining the
number of potentially affected employees in each geographic region that
could have small, medium, and large claims. Then it requires multiplying
the number of potentially affected employees by the corresponding claim
size. Recall that the total number of potentially affected employees is 7,942
2% = 159.
Additional information:

700

S. M. CLOR-PROELL AND L. A. MAINES


United States
and Europe

Asia

Mexico

$1,000$5,000
39

$1,200$4,500
15

$2,000$5,000
33

Cost per employee


Number of affected
employees
Large potential claims:

$28,000$80,000
37

$20,000$80,000
11

$10,000$78,000
8

Cost per employee


Number of affected
employees

$325,000$650,000
10

$400,000$650,000
4

$200,000$650,000
2

Small potential claims:


Cost per employee
Number of affected
employees
Mid-sized potential claims:

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