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James N. Cannon

Assistant Professor of Accounting

Iowa State University

College of Business, 3284 Gerdin Business Building

Iowa State University, Ames, IA 50011 USA


Christine A. Denison

Associate Professor of Accounting

Iowa State University

College of Business, 3115 Gerdin Business Building Iowa State University, Ames, IA 50011 USA caw@iastate.edu October 2014 Acknowledgements This paper is based on James Cannon’s dissertation at the University of Utah. We are grateful to his dissertation committee: Taylor Randall, Rachel Hayes, David Plumlee, Brian Cadman, and Krishnan Anand. We also thank Christine Botosan, Rohit Verma, Hugh M. Cannon, W. Timothy Mitchell, Sue Ravenscroft, anonymous reviewers for the AAA Management Accounting and Accounting, Behavior, and Organization Section meetings, students and faculty from the University of Utah, participants at the 2010 Brigham Young University Accounting Research Symposium, the 2012 AAA Management Accounting Section mid-year meeting and workshop participants at Utah State University, Iowa State University, and Southern Methodist University for their invaluable feedback.



ABSTRACT: This paper examines whether verifiable detail provides a valid source of credibility as defined by believability and trustworthiness in non-financial voluntary disclosures. In an experimental study, we find that customer retention strategy disclosures that include verifiable detail are perceived to be more believable than disclosures that provide no detail. In an archival study, we find that firms with customer retention strategy disclosures that include verifiable detail have ex post performance more consistent with effective customer retention strategy than firms that disclose non-verifiable detail. We conclude from this that firms that provide verifiable detail are more trustworthy than firms that provide non-verifiable detail. In contrast, we find no significant difference in ex post performance of firms that provide disclosures with verifiable detail and that of firms that provide disclosures with no detail. In combination, we infer that it is the verifiability of detail that provides credibility in non-financial disclosure through its believability and trustworthiness.

Keywords: Non-financial disclosure, credibility, verifiability, customer retention strategy.

Data are available from the authors upon request.

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The purpose of this paper is to identify whether verifiable detail provides a valid source of credibility in non-financial disclosures of customer retention strategy. Previous literature has relied on the verifiability of financial information to establish its credibility to users (Hutton et al. 2003). However, there is a lack of research investigating sources of credibility in non-financial strategy disclosure. This is most likely because, unlike much financial information, non-financial strategies are not typically verified ex post through formal accounting oversight processes (i.e. audit). Further, unlike financial disclosure, non-financial disclosure is not often associated with a measureable expected outcome (Hirst et al. 2008).

We address these issues using customer retention strategy disclosure - a setting in which the disclosed information can be informally verified and the expected outcome measured. We examine the credibility of disclosures in that setting by using a multi-method approach to separate two components of credibility, believability and trustworthiness (Cambridge Academic Content Dictionary 1999). First, in an experimental study, we use customer retention strategy disclosure to establish whether detailed statements whose realizations can be verified ex post are perceived as more believable than statements whose realizations cannot be verified ex post. Second, using archival data, we use variation in ex post performance consistent with improved customer retention to establish the trustworthiness of disclosure with verifiable detail, where trustworthiness means a disclosed strategy can be expected to be implemented effectively. In combination, the experimental and archival results allow us to infer whether disclosure users perceive verifiable detail to establish believability and whether verifiable detail signals that a disclosure is trustworthy, by its association with ex post outcomes.

Disclosure provides users with information that is critical to assigning market value to a firm.

While firms are required to disclose some financial information, voluntary disclosure can supplement those requirements by conveying information that helps users evaluate the unique economic conditions of a firm that are not captured by mandatory accounting requirements. In particular, non-financial voluntary disclosure – qualitative information conveyed by managers to market constituents – can be useful in painting a more complete picture of a firm’s economic conditions. In 2003, the United States Securities and Exchange Commission (SEC) issued a press release calling for 10-K Management Discussion and Analysis (MD&A) that “is informative and transparent… to provide information about the quality of, and potential variability of, a company’s earnings and cash flow.” Further, the literature finds that managers make extensive use of non-financial disclosure (Hutton et al. 2003; Baginski et al. 2004; Nichols 2009).

The SEC’s call for informative MD&A and the extensive use of non-financial disclosure suggests that it represents an important medium for management communication.

However, relatively little research examines credibility in non-financial disclosure (Hirst et al.

2008). The research shortfall may arise because it is difficult to establish credibility measures. One way to address this problem is to use an experimental setting in which the believability of a particular nonfinancial disclosure can be measured directly. A second solution is to identify a type of non-financial disclosure that, if credible, is theoretically associated with improved future performance. The disclosure is trustworthy if ex post performance realizations match those established by theory. We use both methods in this paper, conducting an experimental study to directly measure perceptions of non-financial disclosure believability, and conducting an archival study relying on marketing theory to establish signals of trustworthiness by associating verifiable detail within customer retention strategy disclosures with future performance.

We use the setting of customer retention strategy disclosures because it is a setting in which we can make theory-based predictions of ex post performance given credible disclosure. An effective customer retention strategy can give a firm a cost advantage over potential competitors such that abnormal profits exist (e.g. Reichheld and Sasser 1990; Hibbard et al. 2001).1 The firm can signal this expected change in future abnormal profits using credible disclosure, where credibility is established because the disclosure is costly (Spence 1973).2 A firm disclosing its customer retention strategy Potential competitors are firms that, ceteris paribus, would enter a market to pursue abnormal profits. In this paper, a market is defined by a set of customers. Thus, potential competitors include existing firms within an incumbent’s industry that may wish to attract its customers.

There is literature that suggests that costless disclosure, “cheap talk,” also influences outcome. For example, Farrell (1987) suggests that costless disclosure can lead to monopoly-like collusion in a marketplace. Farrell and Rabin (1996) suggest that costless disclosure may indirectly affect outcome, but not market efficiency.

including verifiable detail incurs two types of costs: proprietary costs, which result from the ability of potential competitors to use the disclosed details to create a counter-strategy offsetting the customer retention cost advantage; and commitment costs, which result from holding management responsible for disclosed actions through ex post verification (Lundholm 1999; Hirst et al. 2003; Hutton et al. 2003). For example, consider a customer retention disclosure that describes activities such as the rollout of a sales support program and/or repeat purchase incentives. Each activity provides details that can be used by potential competitors and can be verified ex post, providing a basis for credibility. Alternatively, a disclosure that lacks verifiable detail may be exemplified by a statement that management is placing ‘increased emphasis on customer retention,’ which is cryptic for competitors to interpret and difficult to verify, and thus would not impose as much proprietary or commitment cost on the firm.

We conduct an experimental study to investigate the believability of customer retention strategy disclosures that provide different levels of verifiable detail. We find that customer retention strategy disclosures that provide verifiable detail are perceived as more believable than disclosures that do not provide detail, and that the source of the increased believability lies in the combination of the provision of detail and the verifiability of that detail.

In addition, we conduct an archival study that associates different combinations of detail and verifiability in disclosures of customer retention strategy found in 10-K annual reports with different degrees of future economic performance that is consistent with effective customer retention. We find that firms that include verifiable detail in their disclosures have greater changes in future abnormal profits than firms that include non-verifiable detail. Surprisingly, though, there is no significant difference in changes in future abnormal profits between firms that include verifiable detail in their disclosures and those firms that include no detail. We conclude that it is the verifiability of disclosed detail that provides trustworthiness in customer retention strategy disclosure when a firm discloses implementation details.

However, the perception that disclosures containing verifiable detail are more believable than disclosures containing no detail may lead disclosure users to misplace their trust in the effectiveness of disclosed strategy, as ex post performance between these two groups does not match with their believability.

The remainder of the paper is organized as follows: Section II motivates the importance of nonfinancial voluntary disclosure and the relevance of customer retention strategy as a disclosure topic;

Section III provides a review of relevant literature relating to disclosure believability and disclosure trustworthiness and develops hypotheses; Section IV describes the experimental study research design and results; Section V describes the archival data research design and results; Section VI provides robustness checks and additional analysis useful in interpreting primary results; and Section VII discusses the study’s results and limitations and concludes.


Non-Financial Voluntary Disclosure If markets are to be efficient, corporations must disclose information about their performance and their future prospects (Healy and Palepu 2001). Disclosure regulation was instituted to provide “credible, transparent, and comparable financial information… to make sound investment and credit decisions” (Financial Accounting Standards Board). Although this regulation requires that firms make certain types of disclosures, sufficient diversity exists between firms to invite additional disclosure to inform investment decisions. Voluntary disclosure differs from mandatory disclosure in that it represents managers’ willingness to convey private information even though it is not required (Dye 2001).

Although the purpose of voluntary disclosure is to provide additional information to users about the financial condition of the firm, voluntary disclosure of non-financial information is widespread.

Hutton et al. (2003) and Baginski et al. (2004) report that approximately half of the management forecasts sampled between 1993 and 1997 provide qualitative and open-ended forecasts, as opposed to point and range forecasts. Using management announcement data between 2002 and 2007, Nichols (2009) observes that the number of non-financial disclosures exceeds the number of earnings guidance disclosures.

Despite the common use of non-financial voluntary disclosure, few studies examine characteristics that establish credibility in non-financial disclosures, and even fewer studies examine disclosure characteristics (signals) associated with successful strategies.

Customer Retention Strategy Our paper focuses on voluntary disclosures made about a firm’s customer retention strategy.

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