A recent article in The New York Times argued that disclosure of conflict of interest “often has the opposite of its intended effect, not only increasing bias in advisers but also making advisees more likely to follow biased advice.

The article isn’t any way about disclosure in the context of IFRS, and any extrapolation of it here is entirely due to my own musings, not to the implied encouragement of the author. That said, I couldn’t help thinking some of its observations might apply in the field of financial reporting as well.

Here are some extracts:

• “When I worked as a physician, I witnessed how bias could arise from numerous sources: gifts or sponsorships from the pharmaceutical industry; compensation for performing particular procedures; viewing our own specialties as delivering more effective treatments than others’ specialties. Although most physicians, myself included, tend to believe that we are invulnerable to bias, thus making disclosures unnecessary, regulators insist on them, assuming that they work effectively.
• To some extent, they do work. Disclosing a conflict of interest — for example, a financial adviser’s commission or a physician’s referral fee for enrolling patients into clinical trials — often reduces trust in the advice.
• But my research has found that people are still more likely to follow this advice because the disclosure creates increased pressure to follow the adviser’s recommendation. It turns out that people don’t want to signal distrust to their adviser or insinuate that the adviser is biased, and they also feel pressure to help satisfy their adviser’s self-interest. Instead of functioning as a warning, disclosure can become a burden on advisees, increasing pressure to take advice they now trust less.
• Disclosure can also cause perverse effects even when biases are unavoidable. For example, surgeons are more likely to recommend surgery than non-surgeons. Radiation-oncologists recommend radiation more than other physicians. This is known as specialty bias. Perhaps in an attempt to be transparent, some doctors spontaneously disclose their specialty bias. That is, surgeons may inform their patients that as surgeons, they are biased toward recommending surgery…”

In the area of financial reporting, the greatest echoes of these findings occur perhaps in compensation disclosure and related party transactions, the former being the more egregious example. Management has an obvious incentive to maximize its own wealth; others with a fiduciary duty to the company should have an incentive to resist that drive, to the extent consistent with adequately motivating key individuals. Disclosure of compensation paid to key executives, and of the basis for those amounts, is supposed to reduce weak and self-interested practice in this area, on the theory that “sunlight is the best disinfectant.” This hasn’t worked at all – it now seems likely that disclosing compensation amounts does more to fuel the reckless upward spiral than to control it. The basic mechanisms here might seem much the same as those set out in the Times article: that is (broadly speaking), as long as the amounts are disclosed then they must be justified, regardless of any other considerations.

Nothing new there. But it’s intriguing to reflect on a broader possibility. What if a large amount of the disclosure in the financial statements also operates much as described here? For example, although the notes may spell out various areas of risk and uncertainty, the specific content of these implied warnings may be less impactful than the reassuring compliance ritual they collectively represent. Such a premise would align with repeated anecdotal reports that users seldom fully engage with all the content in the notes, relying excessively on selective and fragmented aspects of what’s available (such as non-GAAP measures).

It’s interesting then, to continue on to the article’s brief list of possible solutions to the problem:

• “When bias is unavoidable, as with specialty bias, options such as patient educational materials could alert patients to this problem without hearing it directly from the physician. Another solution could be multidisciplinary treatment consultations, in which patients meet multiple specialists at the same time. Another remedy is to incorporate mandatory “cooling off” periods for important decisions; this could reduce some pressure advisees feel to follow their advisers’ recommendations.”

The first item, insofar as it has a corollary in financial reporting, would argue for greater specific engagement with what’s being disclosed – no real insight there. It’s not clear to me the other items really apply, even metaphorically. Financial information is already released so long after the dates and periods on which it reports, it’s not really plausible to argue that users should have to wait before they can act on it (but then, I’m not sure it’s entirely plausible in the context of the article either). So the overall lesson, perhaps, would be to embrace the complexity, to take the limitations of financial reporting as being information points as much as they are weaknesses, to avoid simplistic conclusions and interpretations. All eternally good advice of course.

The article’s last line certainly seems relevant: “advisers and policy makers must understand the potential unintended consequences when using disclosure as a solution.” Actually I eliminated the last three words there: “…to manage bias.” But I think my edited version fits here. That is, there may sometimes be unintended consequences in using disclosure as a solution to anything…

The opinions expressed are solely those of the author