Unintended Consequences of Lowering Disclosure Thresholds: Proposed Changes to SFAS No. 5

In recent years, regulators have considered several initiatives to lower the threshold for disclosing risks to investors. We examine two ways in which disclosing more risks can actually lower investors' perceptions of risk. Utilizing an experiment, we find evidence of two unintended consequences on different types of investors. First, we demonstrate that the addition of low-probability risks to a disclosure can dilute (rather than add to) more probable losses, leading certain investors to lower their perceptions of overall risk. Second, since lowering the threshold changes the overall composition of the disclosure by adding low-probability losses, firms could adopt a tactic of minimization that characterizes the entire disclosure as unimportant, presenting the lowest risks most saliently, using compliance with the low threshold as a plausible reason for giving a lengthy disclosure of generally unimportant risks. Our findings suggest that such a tactic can be persuasive.