Managers' Choice of Disclosure Complexity

TL;DR

This paper explores how managers choose financial disclosure complexity, proposing a theory that links complexity with market responses, investor skepticism, and firm characteristics, highlighting the nuanced role of disclosure in financial markets.

Contribution

It introduces a theoretical framework explaining managers' disclosure complexity choices and their market implications, emphasizing the interaction between reporting and economic transactions.

Findings

U-shaped relationship between complexity and returns

Negative association between complexity and investor sophistication

Counterfactual positive market response to complexity

Abstract

Aghamolla and Smith (2023) make a significant contribution to enhancing our understanding of how managers choose financial reporting complexity. I outline the key assumptions and implications of the theory, and discuss two empirical implications: (1) a U-shaped relationship between complexity and returns, and (2) a negative association between complexity and investor sophistication. However, the robust equilibrium also implies a counterfactual positive market response to complexity. I develop a simplified approach in which simple disclosures indicate positive surprises, and show that this implies greater investor skepticism toward complexity and a positive association between investor sophistication and complexity. More work is needed to understand complexity as an interaction of reporting and economic transactions, rather than solely as a reporting phenomenon.