Title: Market Efficiency, Bounded Rationality, and Regulation of Supplemental Business Reporting Disclosures
Authors: J. Richard Dietrich University of Illinois at Urbana-Champaign Steven J. Kachelmeier University of Texas at Austin  Don N. Kleinmuntz,  and Thomas J. Linsmeier University of Illinois at Urbana-Champaign
Date: July1998
Status: working paper

The AICPA's Special Committee on Financial Reporting has urged disclosure of relevant forward-looking and non-financial information to supplement conventional financial statements. We conduct an experiment consisting of 20 laboratory security markets with eight oil firms each to assess the effects of forward-looking non-financial reserve disclosures on capital allocation decisions. We observe four markets in each of five accounting information conditions: a baseline condition with an income statement and balance sheet only and four conditions that combine this baseline with supplemental disclosures of proved reserves (a best estimate), total reserves (a probable upper bound), and minimum reserves (a probable lower bound). We find first that proved reserve disclosures improve capital allocation decisions, even though these disclosures are redundant with information in the primary financial statements. Second, disclosures of the upper bound (total reserves) in the absence of lower bound (minimum reserves) has the potential to bias security prices upwards, while disclosures of both total and minimum reserves remove this bias. Third, a comparison of individual price predictions to actual market prices reveals both a systematic prediction error and a differential effect of supplemental disclosures on security prices. The paper concludes with a discussion of implications for accounting researchers and standard setters.

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