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American Accounting Association

AMERICAN ACCOUNTING ASSOCIATION
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Ben Haimowitz (212-233-6170)

RESTATEMENT ANNOUNCEMENTS
Study warns on hazards of breaking bad company news via video

At a time when YouTube boasts that its users are uploading 24 hours of video every minute, it comes as no surprise that a leading business magazine predicts the written word will soon be supplanted as the basic unit of corporate communications. New research in a leading scholarly accounting journal suggests, though, that for all its vaunted powers, video can present special hazards for a company when those powers are most needed -- namely when there is bad news to report.

Exploring the use of video in announcing company financial restatements, a new study in The Accounting Review, published by the American Accounting Association, suggests that, while the newer medium can help shore up investors' trust, it can also occasion an erosion in trust much more severe than a textual statement is likely to cause.

In the words of the study, "Announcing a restatement online via video is likely to benefit firms only when top management apologizes for the restatement and accepts responsibility by making an internal attribution for the error. When management apologizes but denies responsibility by making an external attribution, announcing a restatement online via video is likely to have unintended negative effects on investors."

What kind of negative effects? Asked to gauge the trustworthiness of a CEO who accepts responsibility via video for his company's flawed financial statements, professional managers gave him 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 bestowed an average of 4.0.

What accounted for this dramatic difference? A single sentence in the middle of the restatement announcement.

Yet, no such striking discrepancy in ratings was seen when the very same CEO announcements were presented in text format, 4.75 when the CEO accepted company responsibility and 4.55 when he laid the blame elsewhere.

"Video announcements of this kind require very special care," comments Frank D. Hodge of the University of Washington's Foster School of Business, who carried out 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."

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% if the chief took responsibility but almost 26% if he blamed outside accountants.

In contrast, the drop was almost the same when the CEO announcements were presented in textual format, about 16% and 13% 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, medium-sized 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 firm'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 chief. Whether in text or video, the announcements were identical except for a single sentence in the middle, artfully spliced into the tape version so that an outsider is highly unlikely to be aware of the insertion.

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 is it that this single sentence on a rather technical matter of lease accounting had such an impact in video? The professors identify trust as a key factor when combined with the magnifying power of video. In the words of the study, "Restating financial statements is inconsistent with investors' positive expectations regarding an investee firm and its management, thus damaging investor trust...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."

Does this suggest that companies should take the blame -- and reap the benefits that video bestows for doing so -- even if the a restatement really does happen to be the fault of outsiders? Prof. Hodge concedes that this can be a tempting option, given that video admissions of fault proved such an effective way of minimizing loss of trust among participants in the study. But, he adds, "Clearly there are ethical and legal reasons not to be that devious. What this study points to is the need to be alert to the powerful effect video has when people's feelings come into play. If outsiders are to blame for your company's restatement, by all means say so, but you'd better make sure you document it and make a strong case for it.

"Plus, for good measure, you still probably need to apologize for letting it happen."

The study, entitled "Using Online Video to Announce a Restatement: Influences on Investment Decisions and the Mediating Role of Trust," is in the March/April issue of The Accounting Review, published six times a year by the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research, and practice. Other journals published by the AAA and its specialty sections include Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Auditing: A Journal of Practice & Theory, and The Journal of the American Taxation Association

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