A new study suggests that using online video to announce a financial restatement can lead to an erosion in investor trust if not handled properly.
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The study, which appears in The Accounting Review, published by the American Accounting Association, found that announcing a financial restatement online through video sites like YouTube is likely to benefit firms only when top management apologizes for the restatement and accepts responsibility internally for the error. However, when management apologizes but shifts responsibility to outside accountants, announcing a restatement via video is likely to have a negative effect on investors.
“Video announcements of this kind require very special care,” said Frank D. Hodge of the University of Washington’s Foster School of Business, who conducted the study with W. Brooke Elliott of the University of Illinois at Urbana-Champaign and Lisa M. Sedor of DePaul University. “Managing the response of investors to events as negative as restatements (which, according to the GAO, reduced market capitalization of companies by $36 billion over a three-year period) is a formidable undertaking. Doing so via video over the Internet makes it all the more formidable.”
Asked to judge the trustworthiness of a CEO who accepts responsibility via video for a company’s flawed financial statement, professional managers gave the CEO an average rating of 6.15 on a scale of 1 to 7. Asked to do the same for a chief who blames external accountants, the managers gave the CEO an average of 4.0.
However, there was no similar large discrepancy when the same CEO statements were presented in text format. The first CEO was rated at 4.75 and the second at 4.55.
The message is reinforced by another finding of the study, regarding willingness to invest in a company following a restatement announcement. Professional managers were asked before and after they learned of the restatement how much they would invest in the company. When they learned of the restatement via a video announcement by the CEO, the amount they intended to invest dropped a mere 3 percent if the chief took responsibility, but almost 26 percent if he blamed outside accountants.
In contrast, the drop was almost the same when the CEO statements were presented in textual format, at about 16 percent and 13 percent respectively.
In their comparison of the two communication formats, the professors recruited 80 professional managers with an average of about nine years’ work experience and asked them to consider the investment-worthiness of a fictional, midsized company with a tradition of good financial results and strong management and a “reputation for open and honest communication with the investment community.” The 80 managers were divided into four equal groups, two of which learned of the financial restatement (the first in the company’s history) via a video announcement by the CEO, as played by a professional actor, and two of which learned via a textual announcement from the CEO. Whether in text or video, the announcements were identical except for a single sentence in the middle spliced into the video version.
In half the versions, the sentence was, “We are fully responsible for this error because we relied on the advice of our internal lease accounting expert when preparing our financial statements.” In the other half, the sentence was, “We are not responsible for this error because we relied on the advice of external lease accounting experts when preparing our financial statements.”
How did a single sentence on a technical matter of lease accounting have such an impact on video? The professors identify trust as a key factor when combined with the magnifying power of video. “Restating financial statements is inconsistent with investors’ positive expectations regarding an investee firm and its management, thus damaging investor trust,” said the study. “Although excuses can be effective, individuals who deny responsibility for a failure (i.e., excuse their behavior by blaming others) risk being viewed as more deceitful and as possessing lower character than are individuals who accept responsibility for the failure. Beliefs about another’s character are key components of trust, and once violated trust is difficult to repair. Even when the violator issues an apology, accepting responsibility by making an internal attribution repairs trust to a greater extent than does denying responsibility by making an external attribution.”