Business strategies and annual report readability

This study investigates the association between firm-level business strategy and the readability of narrative disclosures in annual reports. As business strategy affects the information environment and financial performance of firms, we expect the readability of narrative disclosures to vary with the particular business strategy that a firm pursues. In accord with this expectation, we find that firms with prospector-type business strategies produce less readable narratives, while those with defender-type business strategies produce more readable narratives. We also document that the association between strategy and readability is partially mediated by organisational performance, although the mediation effect is rather modest. These findings are robust when subjected to a series of sensitivity tests.     

The influence of business strategy on annual report readability

Concerns about the complexity of firm disclosures have prompted regulators to initiate projects to improve the readability of annual reports. We investigate business strategy as a determinant of annual report readability. As business strategy fundamentally determines a firm’s product and market domain, technology, and organizational structure, it influences a firm’s operating complexity, environmental uncertainty and information asymmetry. Consequently, business strategy frames the level, wording, and complexity of disclosures. We capture a firm’s business strategy based on the Miles and Snow (1978) strategic typology and measure 10-K readability with Li’s (2008) Fog index. We find that firms pursuing an innovation-oriented prospector strategy have less readable 10-Ks relative to firms pursuing an efficiency-oriented defender strategy. We also find that prospectors display more negative and uncertainty tones while defenders exhibit more litigious tone in their 10-Ks. Our study provides useful insights to policy makers as it suggests that efforts to improve annual report readability may be limited for some firms given that business strategy is a fundamental determinant of readability and pronouncements accommodating different strategic orientations are not feasible.     

Credit default swap spreads and annual report readability

This paper investigates whether annual report readability matters to CDS market participants and how it affects their evaluation on a firm’s credit risk, as measured by CDS spreads. We find that the less readable the annual reports, the higher the CDS spreads. Furthermore, the impact of readability on CDS spreads is more concentrated on firms with high information asymmetry and with investment grade ratings. Our results suggest that investors take into account the readability in their view of the firms’ credit risk. Creditors appear to suffer higher cost on CDS protection of the debts if the underlying firms have less readable annual reports.     

An evaluation of environmental disclosures made in corporate annual reports

This paper evaluates the quality and accuracy of environmental disclosures made in corporate annual reports. Annual report disclosures made by 26 firms in environmentally sensitive industries are examined. An indexing procedure is used to measure the contents of the disclosures, and the relationship between the disclosure contents and the firms' environmental performance is tested. The study provides a detailed measure of environmental disclosure contents. Results indicate that corporate environmental disclosures are incomplete and are not related to the firms' actual environmental performance.     

Readability of narrative disclosures,and corporate liquidity and payout policies

In this paper, we examine the relation between the readability of narrative disclosures in 10-K reports, and corporate liquidity and payout policies. We find that firms with less readable disclosures hold significantly more cash. We also find that this relationship is stronger for firms with weak corporate governance, and with higher financing constraints and refinancing risks. Further analysis also shows that firms with less readable disclosures pay fewer cash dividends and repurchase less stock. Our findings are robust to different estimation methods, and to alternative specifications of key variables. The findings from this study contribute to the emerging research that stresses the importance of 10-K report readability in protecting shareholder wealth.     

Corporate social responsibility orientation and textual features of financial disclosures

This paper examines the relationship between corporate social responsibility (CSR) orientation and textual attributes of financial disclosures. Using a large U.S. sample from 1999 to 2017, we find that firms with high CSR orientation provide more readable disclosures and use a less ambiguous tone in their annual reports. These findings are consistent with the notion that managers in CSR-conscious firms adhere to high ethical standards and commit to improving the transparency of their firms' financial disclosures. Our results are robust to alternative measures of readability and CSR performance, potential endogeneity, and sampling methods. Moreover, in a cross-sectional analysis, we show that the impact of CSR on corporate readability/tone ambiguity is more pronounced for firms with weak corporate governance. Overall, the results suggest that CSR serves as a substitute for traditional corporate governance mechanisms to ensure transparent disclosure.     

Summary annual reports: length,readability and content

This paper examines summary annual reports (SAR) as an alternative channel for communicating financial information. We use a sample of New Zealand local governments (councils) that are required to report audited SAR. Using various measures, we compare document length and readability of SAR and annual reports (AR). We find that SAR are approximately 10 percent of the AR length and both have a ___very difficult___ readability score. We then use a disclosure index to examine the relation between SAR report length and the level of disclosures. After controlling for other factors that impact the level of disclosure, we conclude that the reduction in SAR is driven by lower levels of content. We then discuss the policy implications of our findings.     

Processing Fluency and Investors’ Reactions to Disclosure Readability

The SEC's emphasis on the use of plain English is designed to make disclosures more readable and more informative. Using an experiment, I find that more readable disclosures lead to stronger reactions from small investors, so that changes in valuation judgments are more positive when news is good and more negative when news is bad. Drawing on research in psychology to explain this result, I predict and find that processing fluency from a more readable disclosure acts as a subconscious heuristic cue and increases investors’ beliefs that they can rely on the disclosure. Although I do not find that more readable disclosures directly increase perceptions of management credibility, I do find evidence of an indirect effect operating through feelings of processing fluency. In supplemental analyses, I find that investors who receive more readable disclosures revise their valuation judgments to be less extreme when they are explicitly made aware of the potential for variation in readability. I discuss potential explanations for these revised valuation judgments.     

Public policy and venture capital: Pursuing the disclosure goal

Using a sample of US firms that went public between 2000 and 2011, we conduct a textual analysis of 10-K filings to jointly evaluate the impact of the Sarbanes-Oxley Act and venture capital (VC) on the disclosure practices of both VC- and non-VC-backed IPOs. We find that the annual reports of VC-backed IPOs are much more readable than the annual reports of their peers. This finding suggests that VCs introduce more clarity into financial reporting to improve the reaction in the firm market price to create value and feed their own reputation. On the contrary, we find that the Sarbanes-Oxley Act forces firms to produce longer 10-Ks consistent with the aim of the reform (Title IV) to enhance financial disclosures. In turn, this ends up to negatively impact on the readability.     

Disclosure Practices by Family Firms: Evidence from Swedish Publicly Listed Firms

Abstract

I investigate the effect of family ownership on firms’ disclosure practices in their annual reports. In specific, I study Swedish publicly listed firms, which are typically characterized by controlling owners that have a strong influence in the corporate governance decisions of the firm, including corporate disclosures. To measure disclosure, I construct a comprehensive disclosure index covering information on (1) corporate governance, (2) strategic and financial targets and (3) notes to the financial statements. The results reveal that overall, family firms provide less disclosure in annual reports than non-family firms do. The finding is consistent with the premise that through their management positions, family owners can directly monitor managers and avoid costly public disclosures. Overall, the results suggest that ownership structure of firms is important to consider in understanding firms’ disclosure incentives, particularly in settings where controlling owners play a significant role in the governance of the firm.     

Risk reporting: A study of risk disclosures in the annual reports of UK companies

The concepts of risk and risk management have received considerable attention lately, but this has yet to be reflected in empirical research examining firms’ risk reporting practices. This study seeks to address this gap in the literature and explores risk disclosures within a sample of 79 UK company annual reports using content analysis. A significant association is found between the number of risk disclosures and company size. Similarly a significant association is found between the number of risk disclosures and level of environmental risk as measured by Innovest EcoValue`21™ Ratings. However, no association is found between the number of risk disclosures and five other measures of risk: gearing ratio, asset cover, quiscore, book to market value of equity and beta factor. The paper also discusses the nature of the risk disclosures made by the sample companies specifically examining their time orientation, whether they are monetarily quantified and if good or bad risk news is disclosed. It was uncommon to find monetary assessments of risk information, but companies did exhibit a willingness to disclose forward-looking risk information. Overall the dominance of statements of general risk management policy and a lack of coherence in the risk narratives implies that a risk information gap exists and consequently stakeholders are unable to adequately assess the risk profile of a company.     

Female leadership in corporate social responsibility reporting: Effects on writing,readability and future social performance

This study examines how the gender of corporate social responsibility (CSR) leaders (as signers of the CSR reports) could affect two psychometric properties (i.e., solidarity and certainty) and the readability of the reports. We also investigate how these gender-based differences are associated with firms' future perceived social performance. We conduct textual analyses on a sample of 346 firms in the S&P500 index that issued annual CSR reports during the period of 2006 to 2015. Our findings show that CSR reports with a female (vis-à-vis male) executive as the signer or co-signer are more readable, show more solidarity with readers, but express less certainty in the narratives. In examining their impacts, we find that readability and solidarity, but not certainty, are positively associated with firms' future social performance. Our results suggest the value relevance of leveraging greater female representation in firms' CSR reporting leadership teams so as to help firms enhance their social objectives and signal their future social performance.     

Pricing of Foreign GAAP Earnings in U.S. Capital Market Prior to the SEC Required Reconciliation Disclosure

The Securities and Exchange Commission (SEC) requires foreign registrants to include in their annual reports on Form 20-F reconciliation to U.S. GAAP of net income, earnings per share, and shareholders' equity, if materially different. Previous research indicates that foreign firms usually file their reports with the SEC near or at the deadline, that is six months after the fiscal year-end and about three months after the earnings announcement. The purpose of this study is to examine U.S. investors' ability to interpret foreign GAAP earnings before the SEC regulated disclosure becomes publicly available. Presented empirical evidence indicates that market participants are able to infer U.S. GAAP earnings from the foreign GAAP earnings at the time of initial earnings announcements.     

Extent of environmental disclosure of U.S. and Canadian firms by annual report location

This study discusses various influences on firms to provide additional environmental disclosure and empirically measures and analyzes the extent of actual environmental disclosures included in the annual reports of firms in the U.S. and Canada. The environmental disclosure content provided in the annual reports of firms is evaluated based on environmental reporting guidelines published by the American Institute of Public Accountants and the Canadian Institute of Chartered Accountants. In general, the results indicate that U.S. firms provided a significantly higher level of environmental disclosure than did Canadian firms. Also, firms in each nation varied significantly in the amount of environmental disclosure provided in each of four annual report sections.     

Motivations behind human capital disclosure in annual reports

Although much has been discussed about voluntary disclosure of human capital in annual reports there has been limited examination of the motivations behind such disclosure. This study uses the perspective of the political economy of accounting to understand motivations. Using the method of content analysis, this paper examines human capital disclosure practices in annual reports of a sample of firms in Sri Lanka, a developing nation. Eleven case study interviews from the sample explore the motivations behind the disclosure practices of firms. Findings reveal that firms use disclosure to reduce tension between firms and their constituents, in the interest of further capital accumulation.     

Managerial Ownership and Accounting Disclosures: An Empirical Study

This study examines empirically the effect of managerial ownership on firms' disclosures. Agency theory predicts that investors' information requirements increase with the agency costs of the firm. Managerial ownership mitigates agency costs and therefore should reduce investors' information needs. This study tests the hypothesis that firms with lower levels of managerial ownership provide more extensive disclosures by examining analysts' ratings of firms' disclosures. In contrast to the proxies used in prior studies that test this relationship, such as the earnings-return correlation and management earnings forecasts, these ratings provide a more direct measure of firms' overall disclosure practices.I find that the relationship between managerial holdings and disclosures depends on the type of disclosure. Consistent with the hypothesis of this study, firms with lower levels of managerial ownership are more likely to receive higher ratings for the disclosures provided in their annual and quarterly reports, even after controlling for size, performance, volatility of returns, the frequency of securities offerings and proprietary costs. The more informal and flexible aspects of disclosures, however, as measured by the investor relations rating, are not influenced by the level of managerial ownership. These results are consistent with prior research that predicts that firms lower their costs of capital by signaling a commitment to maintain a more open disclosure policy. Because annual and quarterly reports are less flexible, and therefore less likely to change, they may represent a more credible commitment to provide more informative disclosures.     

Employment quality and 10-K report readability

This study examines the relationship between firms’ employment quality and annual report readability. Using 9,366 U.S. firm-year observations from 1994 to 2018, we find that a favorable employment quality is positively associated with a more readable 10-K report. Such a positive relationship can be observed when firms recruit industry-specialist auditors and when employees are considered important stakeholders to the firm. However, we find a negative association between employment quality and 10-K report readability when there is a presence of firm-level unionization. Our findings inform policymakers that initiatives to promote disclosure readability may be undermined by firms that place less emphasis on employment quality. Further, firm-level unionization can reduce the incentive for firms with a favorable employment quality to provide readable disclosures.     

Retrieving,classifying and analysing narrative commentary in unstructured (glossy) annual reports published as PDF files

We provide a methodological contribution by developing, describing and evaluating a method for automatically retrieving and analysing text from digital PDF annual report files published by firms listed on the London Stock Exchange (LSE). The retrieval method retains information on document structure, enabling clear delineation between narrative and financial statement components of reports, and between individual sections within the narratives component. Retrieval accuracy exceeds 95% for manual validations using a random sample of 586 reports. Large-sample statistical validations using a comprehensive sample of reports published by non-financial LSE firms confirm that report length, narrative tone and (to a lesser degree) readability vary predictably with economic and regulatory factors. We demonstrate how the method is adaptable to non-English language documents and different regulatory regimes using a case study of Portuguese reports. We use the procedure to construct new research resources including corpora for commonly occurring annual report sections and a dataset of text properties for over 26,000 U.K. annual reports.     

Annual report readability and stock liquidity

We examine the effect of annual report textual complexity on firms’ stock liquidity. Using techniques from computational linguistics, we predict and find that less readable filings are associated with lower stock liquidity. Our study provides evidence that difficult‐to‐read annual reports hinder investors’ ability to process and analyze information contained in corporate annual reports, reducing thereby their willingness to trade which decreases stock liquidity. Our findings are robust to a battery of sensitivity tests, including endogeneity, use of alternative estimation techniques, and use of alternative liquidity and readability proxies.     

Cross-market information transfers of ADR firms: An investigation of emerging market economies

Level II and III ADRs permit issuers to be listed on the major U.S. exchanges with the stipulation that they comply with extensive SEC disclosure requirements. Foreign private issuers are compelled to file a set of audited financial statements prepared in accordance with U.S. GAAP, or alternatively, IFRS or Home Country Accounting Principles with attendant reconciliation to U.S. GAAP prior to 2008. Although the Form 20-F reconciliation is discontinued in 2008 for IFRS filers, non-U.S. issuers are required to satisfy other Form 20-F stipulations such as expanded Item 17 and Item 18 disclosures. We conjecture that non-U.S. firms choosing to be listed on the major U.S. exchanges will incur the added costs associated with the supplemental disclosure requirements in order to attract sufficient investor attention as to have the disclosures impounded in the home country equity share price in the manner described by Fishman et al. (1989). Because a prominent attribute of ADR firms is that they benefit from multiple-market trading, we investigate whether the Form 20-F disclosure cross-market information transfers are associated with emerging market economy status. We employ models of the cross-market ADR and equity security share returns and trading volume controlling for the emerging economy status and incremental firm-specific SEC Form 20-F accounting principles disclosures. Preliminary results indicate that (1) U.S. listed ADR firms from emerging economies experience greater cross-market information transfers associated with the SEC Form 20-F filing, and (2) that the increased cross-market information transfers associated with the SEC Form 20-F filing are proportional to the difference in quality of accounting principles employed for home country reporting purposes vis-à-vis the accounting principles employed for SEC Form 20-F reporting purposes. Results are consistent with a feedback process through which the new information disclosed by the SEC Form 20-F reporting requirements in the ADR market attenuates the price discovery process in the home country equity market when the difference in information environment quality is large.