Abstract
Annual reports are the primary source of information for investors. It contains all the details about the company’s activities in the preceding financial year. About 80% of an annual report is text (Cheng et al. 2018); hence proper comprehension and readability enhance the usefulness of the information. Earlier researches prove the positive relationship between firm performance and annual report readability (Li 2008). Studies also find that complexity is a deliberate attempt by companies to obfuscate earnings management and poor performance (Bloomfield 2008). Against this backdrop, we investigate the relationship between firm value, financial performance and annual report readability in the Indian context. For this purpose, we use Gunning Fog Index (Flesch Kincaid index, Smog index, and File size as robustness checks) to measure the annual report readability of NSE 500 firms for the period 2016 to 2020. We find a positive relationship between firm performance (Tobin’s Q, ROA, and ROCE) and annual report readability. Further, this paper finds a positive relationship between the annual report readability and firm value (Tobin’s Q and ROA) in the next year. The findings will be helpful for the investors as it shows how vital is annual report readability in signaling future firm value. It shows the readability of the narrative content as an important signal about a firm’s current performance and prospects. This paper recommends that the management be more cautious while preparing financial disclosures because complex disclosures may send negative signals to the investors about the firm’s prospects.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
National Stock Exchange.
When there is suspected endogeneity among the independent variables, then estimators of OLS or Random Effects may be biased and lead to misleading inferences (Baltagi et al. 2003). HT Model has been widely used as a solution for this problem. HT estimator handles the data setting properly, when some of the independent variables are correlated with the individual effects. The estimation is normally based on the IV methods, and the instruments will be derived from internal data transformations of the variables in the model. So external information is not required for the model estimation. HT Model avoids the “all or nothing” assumption concerning the correlation between error terms and independent variables, which is the usual assumption made in the standard FE and RE Model approaches, respectively. To implement the HT Model, one needs to classify the variables as correlated and uncorrelated with the individual effects (Mitze 2009).
References
Adelberg, A.H. 1979. Narrative disclosures contained in financial reports: Means of communication or manipulation? Accounting and Business Research 9 (35): 179–190. https://doi.org/10.1080/00014788.1979.9729157.
Ajina, A., M. Laouiti, and B. Msolli. 2016. Guiding through the Fog: Does annual report readability reveal earnings management? Research in International Business and Finance 38: 509–516. https://doi.org/10.1016/J.RIBAF.2016.07.021.
Arora, S., and Y. Chauhan. 2022. Do earnings management practices define the readability of the financial reports in India? Journal of Public Affairs 22 (4): e2692. https://doi.org/10.1002/PA.2692.
Bacha, S., and A. Ajina. 2020. CSR performance and annual report readability: Evidence from France. Corporate Governance (bingley) 20 (2): 201–215. https://doi.org/10.1108/CG-02-2019-0060/FULL/XML.
Baltagi, B.H., G. Bresson, and A. Pirotte. 2003. Fixed effects, random effects or Hausman–Taylor?: A pretest estimator. Economics Letters 79 (3): 361–369. https://doi.org/10.1016/S0165-1765(03)00007-7.
Barron, O.E., C.O. Kile, and T.B. O’Keefe. 1999. MD&A quality as measured by the SEC and analysts’ earnings forecasts*. Contemporary Accounting Research 16 (1): 75–109. https://doi.org/10.1111/J.1911-3846.1999.TB00575.X.
Barth, M.E., R. Kasznik, and M.F.M. Cnichols. 2001. Analyst coverage and intangible assets. Journal of Accounting Research 39 (1): 1–34.
Biswas, P.K., and S.K. Bala. 2016. Usefulness of corporate annual reports to individual investors in Bangladesh. International Journal of Disclosure and Governance 13 (2): 97–116. https://doi.org/10.1057/JDG.2015.11/METRICS.
Blanco, B., P. Coram, S. Dhole, and P. Kent. 2021. How do auditors respond to low annual report readability? Journal of Accounting and Public Policy 40 (3): 106769. https://doi.org/10.1016/J.JACCPUBPOL.2020.106769.
Bloomfield, R. 2008. Discussion of “Annual report readability, current earnings, and earnings persistence.” Journal of Accounting and Economics 45 (2–3): 248–252. https://doi.org/10.1016/J.JACCECO.2008.04.002.
Bloomfield, R. J. (2002). The “Incomplete Revelation Hypothesis” and financial reporting. In SSRN Electronic Journal. Elsevier BV. https://doi.org/10.2139/SSRN.312671
Castellano, K.E., S. Rabe-Hesketh, and A. Skrondal. 2014. Composition, context, and endogeneity in school and teacher comparisons. Journal of Educational and Behavioral Statistics 39 (5): 333–367. https://doi.org/10.3102/1076998614547576.
Chang, Y.Y., S. Dasgupta, and G. Hilary. 2010. CEO ability, pay, and firm performance. Management Science 56 (10): 1633–1652. https://doi.org/10.1287/MNSC.1100.1205.
Cheng, J., Zhao, J., Xu, C., & Gong, H. 2018. Annual report readability and earnings management: Evidence from Chinese listed companies. In Proceedings of the 2018 4th international conference on social science and higher education (ICSSHE 2018). https://doi.org/10.2991/ICSSHE-18.2018.199
Cho, M., J. Hyeon, T. Jung, and W.J. Lee. 2019. Audit pricing of hard-to-read annual reports. Asia-Pacific Journal of Accounting & Economics 29 (2): 547–572. https://doi.org/10.1080/16081625.2019.1600418.
Chuang, H.H.-C., G. Lu, D.X. Peng, and G.R. Heim. 2014. Impact of value-added service features in e-retailing processes: An econometric analysis of web site functions. Decision Sciences 45 (6): 1159–1186. https://doi.org/10.1111/DECI.12105.
Chychyla, R., A.J. Leone, and M. Minutti-Meza. 2019. Complexity of financial reporting standards and accounting expertise. Journal of Accounting and Economics 67 (1): 226–253. https://doi.org/10.1016/J.JACCECO.2018.09.005.
Clarkson, P.M., J.L. Kao, and G.D. Richardson. 1999. Evidence that management discussion and analysis (MD&A) is a part of a firm’s overall disclosure package*. Contemporary Accounting Research 16 (1): 111–134. https://doi.org/10.1111/J.1911-3846.1999.TB00576.X.
Clatworthy, M., and M.J. Jones. 2001. The effect of thematic structure on the variability of annual report readability. Accounting, Auditing & Accountability Journal 14 (3): 311–326. https://doi.org/10.1108/09513570110399890/FULL/XML.
Dalwai, T., G. Chinnasamy, and S.S. Mohammadi. 2021. Annual report readability, agency costs, firm performance: An investigation of Oman’s financial sector. Journal of Accounting in Emerging Economies 11 (2): 247–277. https://doi.org/10.1108/JAEE-06-2020-0142/FULL/XML.
Davis, A.K., and I. Tama-Sweet. 2012. Managers’ use of language across alternative disclosure outlets: earnings press releases versus MD&A*. Contemporary Accounting Research 29 (3): 804–837. https://doi.org/10.1111/J.1911-3846.2011.01125.X.
Dawkins, C.E., and J.W. Fraas. 2008. An exploratory analysis of corporate social responsibility and disclosure. Business & Society 52 (2): 245–281. https://doi.org/10.1177/0007650308324047.
DeFond, M., and J. Zhang. 2014. A review of archival auditing research. Journal of Accounting and Economics 58 (2–3): 275–326. https://doi.org/10.1016/J.JACCECO.2014.09.002.
Dempsey, S.J., D.M. Harrison, K.F. Luchtenberg, and M.J. Seiler. 2012. Financial opacity and firm performance: The readability of REIT annual reports. Journal of Real Estate Finance and Economics 45 (2): 450–470. https://doi.org/10.1007/S11146-010-9263-2/METRICS.
Flammer, C. 2015. Does corporate social responsibility lead to superior financial performance? A regression discontinuity approach. Management Science 61 (11): 2549–2568. https://doi.org/10.1287/MNSC.2014.2038.
Grossman, S.J., and J.E. Stiglitz. 1980. On the impossibility of informationally efficient markets on JSTOR. The American Economic Review 70 (3): 393–408.
Gunning, R. 2016. The fog index after twenty years. International Journal of Business Communication 6 (2): 3–13. https://doi.org/10.1177/002194366900600202.
Habib, A., and M.M. Hasan. 2020. Business strategies and annual report readability. Accounting & Finance 60 (3): 2513–2547. https://doi.org/10.1111/ACFI.12380.
Huang, H., E. Lee, C. Lyu, and Y. Zhao. 2020. Bequest motive, information transparency, and family firm value: A natural experiment. Journal of Corporate Finance 65: 101751. https://doi.org/10.1016/J.JCORPFIN.2020.101751.
Iyer, A., H. Saranga, and S. Seshadri. 2013. Effect of quality management systems and total quality management on productivity before and after: Empirical evidence from the indian auto component industry. Production and Operations Management 22 (2): 283–301. https://doi.org/10.1111/POMS.12000.
Jameson, M., A. Prevost, and J. Puthenpurackal. 2014. Controlling shareholders, board structure, and firm performance: Evidence from India. Journal of Corporate Finance 27: 1–20. https://doi.org/10.1016/J.JCORPFIN.2014.04.003.
Jeanjean, T., C. Lesage, and H. Stolowy. 2010. Why do you speak English (in your annual report)? The International Journal of Accounting 45 (2): 200–223. https://doi.org/10.1016/J.INTACC.2010.04.003.
Jeanjean, T., H. Stolowy, M. Erkens, and T.L. Yohn. 2015. International evidence on the impact of adopting English as an external reporting language. Journal of International Business Studies 46 (2): 180–205. https://doi.org/10.1057/JIBS.2014.33/TABLES/11.
Jones, M.J. 1996. Commentaries: Readability of annual reports: Western versus Asian evidence - A comment to contexualize. Accounting, Auditing & Accountability Journal 9 (2): 86–91. https://doi.org/10.1108/09513579610116376.
Klare, G.R. 2000. The measurement of readability: Useful information for communicators. ACM Journal of Computer 24 (3): 107–121.
Kothari, S.P., X. Li, and J.E. Short. 2009. The effect of disclosures by management, analysts, and business press on cost of capital, return volatility, and analyst forecasts: A study using content analysis. The Accounting Review 84 (5): 1639–1670. https://doi.org/10.2308/ACCR.2009.84.5.1639.
Kumar, G. 2014. Determinants of readability of financial reports of U.S.-listed Asian companies. Asian Journal of Finance & Accounting 6 (2): 1. https://doi.org/10.5296/ajfa.v6i2.5695.
Laksmana, I., W. Tietz, and Y.W. Yang. 2012. Compensation discussion and analysis (CD&A): Readability and management obfuscation. Journal of Accounting and Public Policy 31 (2): 185–203. https://doi.org/10.1016/J.JACCPUBPOL.2011.08.003.
Laughlin, G.H.M. 1969. SMOG grading-a new readability formula on JSTOR. Journal of Reading 12 (8): 639–646.
Lehavy, R., F. Li, and K. Merkley. 2011. The effect of annual report readability on analyst following and the properties of their earnings forecasts. The Accounting Review 86 (3): 1087–1115. https://doi.org/10.2308/ACCR.00000043.
Li, F. 2008. Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics 45 (2–3): 221–247. https://doi.org/10.1016/J.JACCECO.2008.02.003.
Lim, E.K.Y., K. Chalmers, and D. Hanlon. 2018. The influence of business strategy on annual report readability. Journal of Accounting and Public Policy 37 (1): 65–81. https://doi.org/10.1016/J.JACCPUBPOL.2018.01.003.
Lo, K., F. Ramos, and R. Rogo. 2017. Earnings management and annual report readability. Journal of Accounting and Economics 63 (1): 1–25. https://doi.org/10.1016/J.JACCECO.2016.09.002.
Loughran, T., and B. Mcdonald. 2014. Measuring readability in financial disclosures. The Journal of Finance 69 (4): 1643–1671. https://doi.org/10.1111/JOFI.12162.
Lu, G., X. Ding, D.X. Peng, and H.H.-C. Chuang. 2018. Addressing endogeneity in operations management research: Recent developments, common problems, and directions for future research. Journal of Operations Management 64: 53–64. https://doi.org/10.1016/J.JOM.2018.10.00.
Merkl-Davies, A. n.d. Title discretionary disclosure strategies in corporate narratives: Incremental information or impression management? http://hdl.handle.net/10197/2907
Mitze, T. 2009. Endogeneity in panel data models with time-varying and time-fixed regressors: To IV or not IV? In SSRN electronic journal. Elsevier BV. https://doi.org/10.2139/SSRN.1358224
Renders, A., and A. Gaeremynck. 2012. Corporate governance, principal-principal agency conflicts, and firm value in European listed companies. Corporate Governance: An International Review 20 (2): 125–143. https://doi.org/10.1111/J.1467-8683.2011.00900.X.
Rutherford, B.A. 2003. Obfuscation, textual complexity and the role of regulated narrative accounting disclosure in corporate governance. Journal of Management and Governance 7 (2): 187–210. https://doi.org/10.1023/A:1023647615279/METRICS.
Sabherwal, R., and S. Sabherwal. 2007. How do knowledge management announcements affect firm value? A study of firms pursuing different business strategies. IEEE Transactions on Engineering Management 54 (3): 409–422. https://doi.org/10.1109/TEM.2007.900785.
Subramanian, R., R.G. Insley, and R.D. Blackwell. 1993. Performance and readability: A comparison of annual reports of profitable and unprofitable corporations. International Journal of Business Communication 30 (1): 49–61. https://doi.org/10.1177/002194369303000103.
Tariq, Y.B., and Z. Abbas. 2013. Compliance and multidimensional firm performance: Evaluating the efficacy of rule-based code of corporate governance. Economic Modelling 35: 565–575. https://doi.org/10.1016/J.ECONMOD.2013.08.015.
Tavcar, L.R. 1998. Make the MD&A more readable. The CPA Journal 68 (1): 10.
Téllez, D., González, M., Guzmán, A., & Trujillo, M. A. 2017. What do you say and how do you say it: Information disclosure in Latin American firms. Documentos de Trabajo CIEF. https://ideas.repec.org/p/col/000122/016358.html
Xu, H., T.H. Pham, and M. Dao. 2020. Annual report readability and trade credit. Review of Accounting and Finance 19 (3): 363–385. https://doi.org/10.1108/RAF-10-2019-0221/FULL/XML.
Xu, H., M. Dao, J. Wu, and H. Sun. 2022. Political corruption and annual report readability: Evidence from the United States. Accounting and Business Research 52 (2): 166–200. https://doi.org/10.1080/00014788.2020.1815516.
Funding
All authors certify that they have no affiliations with or involvement in any organization or entity with any financial interest or non-financial interest in the subject matter or materials discussed in this manuscript. The authors have no financial or proprietary interests in any material discussed in this article.
Author information
Authors and Affiliations
Corresponding author
Ethics declarations
Conflict of interest
On behalf of all the authors, the corresponding author states that there is no conflict of interest.
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Rights and permissions
Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.
About this article
Cite this article
Gangadharan, V., Padmakumari, L. Fogging the firm performance: an empirical examination of the annual report readability in India. Int J Discl Gov (2023). https://doi.org/10.1057/s41310-023-00195-3
Received:
Accepted:
Published:
DOI: https://doi.org/10.1057/s41310-023-00195-3