Abstract
Corporate disclosures represent the main formal source of information for investors and other stakeholders. For both regulatory policies and academic research, the quality of information still elicits great interest as a key determinant of the decision-making of market participants. In conjunction with the rapid changes in the business landscape and the continuous advances in information technology, the market participants’ needs for information continue to evolve accordingly. This mutual and rapid change in the corporate information environment comes with its share of challenges for organizations to adapt their communication policy to be tuned to the highest disclosure standards and requirements.This thesis aims to analyze the quality of corporate disclosures by having a particular focus on the readability of annual reports of US listed companies. The area of readability of corporate disclosures has indeed developed a great deal of interest from regulators, policymakers, and academics in recent years. The thesis aims to provide additional insights into the key determinants of annual report readability. It starts by providing an overview of the literature on corporate disclosure readability through a systematic review approach in Chapter I1. Corporate disclosure does not come without costs. Chapter II examines the propriety costs of disclosures and investigates their effects as reflected in corporate market competition on annual report readability. Since readability is typically associated with manager obfuscation behavior, Chapter III explores whether and how annual report readability is affected by agency costs associated with increased managerial discretion likelihood in dual- class firms. Business ethics embedded in high-quality and transparent corporate disclosures are
[1 The notions of “corporate disclosure readability” and “annual report readability”, though related, address different aspects of financial communication. Corporate disclosure readability pertains to the clarity of various documents and communications released periodically by a company, such as financial statements, press releases, regulatory filings, and management discussions. These disclosures aim to provide timely and relevant information to stakeholders like investors, regulators, and the public, helping them make informed decisions. On the other hand, annual report readability focuses specifically on the comprehensive document released once a year, detailing the company's financial performance, management's analysis, and future outlook. Annual reports include detailed financial statements, qualitative analyses, and graphical representations, offering a thorough yearly overview to investors, shareholders, and analysts. While corporate disclosures are frequent and vary in format and length, annual reports follow a structured format and provide a broader, in-depth analysis of the company’s performance and strategy.] also highly influenced by moral values, in particular, religious norms. Chapter VI is devoted to the study of the effect of corporate religiosity on annual report readability.
The readability of corporate disclosure is essentially based on the analysis of the quality of textual narratives. Managers provide textual narratives in many passages of the annual report, such as in the management discussion and analysis (MD&A) section, financial statement footnotes, risk factor section, and other details and descriptions of accounting information. Moreover, accounting systems usually offer a variety of rules, methods, principles, options, and interpretations, such that managers should thoroughly present and explain their reporting approach in a formal, detailed, and explicit form. Such textual information naturally broadens the knowledge of readers above and beyond numbers, whereby textual narratives may have an incremental explanatory power that is likely to add value- relevance to users. The behavior of managers is at the center of corporate disclosure readability. Most importantly, opportunistic managers might use difficult-to-read disclosure as a subterfuge to intentionally obfuscate some information, generally related to bad news, thus adopting an obfuscation behavior. They intend to hinder users’ ability to process and analyze potentially highly value-relevant information that the company does not want to reveal (Bloomfield 2002).
Due to its significant effect on capital markets, the quality of financial reporting has long been the subject of a heated debate among regulators in implementing corporate disclosure policies. In the U.S., the Securities and Exchange Commission (SEC) has always been and continues to be at the forefront of this debate. It acknowledged that the usefulness of financial information is fundamentally related to its easy understandability by readers and, thus, readability (SEC, 1998). In this sense, Statement of Financial Accounting Concepts (SFAC) No.2 stipulates that “information is not useful if it is not understandable to its target users.” The most concrete action of the Securities and Exchange Commission (SEC) towards the improvement of corporate disclosures’ readability was the promulgation in 1998 of the plain English Mandate (SEC Rule 421(d)), which requires issuers to use plain English in writing their prospectuses. Public companies are also strongly encouraged to use easy language for all their communication in a way that makes financial documents readily accessible to and understandable by the general public (SEC, 1998).
However, the efforts put by the SEC and other regulatory bodies worldwide into ensuring the readability of corporate disclosures may create a paradox when accompanied by increased formal and informal requirements for companies to provide more comprehensive and detailed information as well as additional explanations and comments on some specific and complex topics of the annual report. This paradox is mainly related to the fact that the SEC permanently recommends companies avoid lengthy sentences in financial reporting and, in general, long written textual disclosures (SEC, 1998). This raises the main question of whether increases in corporate disclosures involve more value-relevant or less value-relevant information to users and, thus, higher or lower readability levels. For example, Radin (2007), a US CPA, ascertained that financial information as companies provide it is written to comply with the accounting regulations rather than to be read.
The many challenges that companies face in their disclosure policies give rise to evolutions in the field of accounting and finance research, in particular, in the literature on corporate disclosure readability. This literature acknowledges that the notion of readability is tightly related to “the effective communication of valuation-relevant information.” which is essentially grounded on how the general information user can easily understand it (Pound, 1981; Loughran and McDonald, 2014a). The main results from this literature converge towards the notion that the use of vague and complex language in annual reports increases market concern about investors’ perceptions and behavior, which translates into significant market inefficiencies. Research in this area collectively supports the view that corporate disclosure policy should primarily consider the ability of investors and other users of financial information to easily comprehend the meanings of the message conveyed by managers to use it efficiently in their decision-making.
The literature highlighted the importance of corporate disclosure readability for users in many respects. First, by nature, narratives unconsciously give cause-effect events to the reader and represent thus a solid tool for bridging the gap between accounting numbers and the firm’s business fundamentals by explicitly relating numbers to the economic and financial context (Davis et al., 2012a). Narrative disclosures are, indeed, a rich source of information that report and describe data, accounting policies, and economic events (Li, 2010a). Thus, if accounting numbers are biased or are insufficiently informative when taken alone, accounting narratives would play a particularly salient informational role since only very few market actors can directly observe firms’ activities and thus adequately understand numbers. Second, analyzing narratives could give readers many various directions and opportunities to understand and interpret all the aspects of a particular event, such as earnings announcements, acquisitions, or mergers, rather than strictly considering that event from the perspective offered by numbers (Li. 2010b; Davis et al., 2012b; Bozanic et al., 2018). Thus, narratives may provide a more comprehensive vision of economic events that influence firms’ fundamentals, which
allows a better understanding of the firm and market behavior. Third, many studies document that financial narratives may provide a signal of managers’ expectations about future performance (Bryan, 1997; Henry, 2006; Engelberg, 2008). The market participants will respond according to their perception of the manager's message, which is mainly involved in narrative text.
The first step towards better annual report readability is to broaden our understanding of its determinants and implications for investors and other corporate stakeholders. Chapter I develops a literature review on the readability of corporate textual disclosures based on a systematic review which is designed using the reporting checklist of the Preferred Reporting Items for Systematic Reviews and Meta-Analyses (PRISMA; Liberati et al., 2009). This approach is grounded on a search strategy that is based on screening target papers on the readability of corporate disclosure from the most relevant search engines for academic research. The search strategy is designed using the combination of two sets of list terms. The first list contains terms related to readability, whereas the second list includes words referring to the different types of corporate disclosures. Many inclusion and exclusion criteria are applied to obtain the final sample for my systematic review. The screened papers have been published in journals appearing in ABDC- master journal list from 1980 to June 2021. Most of them draw from three different research disciplines, namely finance and accounting, computational analysis, and linguistics and communication. Even if the ABS list is more appropriate and more relevant regarding the United Kingdom context of the thesis, it remains less exhaustive compared to the ABDC list. As I aim to include as many journals as possible, this list has been privileged. As the ABS list is only a subset of this ABDC list, there is no clear reason why the results will vary depending on that.
This chapter addresses the following research questions: (i) What are the main textual attributes of financial disclosures that could make such disclosures more readable and thus more useful? (ii) How does managerial behavior affect the readability of corporate textual disclosures? What is the role of agency problems, information asymmetry, and corporate governance in this relationship? and (iii) What are the principal exogenous factors that may affect the readability of corporate textual disclosures? This systematic review offers new insights into the literature overview of corporate disclosure readability in so far as it updates previous reviews by highlighting the recent trends and developments in readability approaches. It also integrates a broader range of stakeholders −rather than the only investor perspective. Moreover, it investigates the relevance of many endogenous and exogenous factors for corporate narratives’ readability.
In the second step, Chapter II explores the proprietary costs of corporate disclosure stemming from competition by investigating the effect of product market competition on annual report readability. In the extant literature, it is suggested that competition imposes important proprietary costs of disclosure on the firm, leading firms to face intense competitive pressure to hide their private information from rivals (Verrecchia, 1983). A likely implication is that product market competition decreases annual report readability to preserve the value of proprietary information from rivals in highly competitive industries. The intensity of product market competition is measured by market fluidity based on a textual analysis of product descriptions found in firms’10–K filings as follows from Hoberg et al. (2014). This measure gauges the similarity between a firm’s products and the overall change in rivals’ products. The more rivals change their products that are similar to an incumbent firm’s products, the greater the forward-looking competitive threats that the incumbent firm would face. Hence, higher values of market fluidity reflect higher product market competition.
This chapter significantly contributes to the existing literature on the relationship between the threat of competition and voluntary corporate disclosure. Most prior studies in this stream of research focus on the effect of competition on quantitative disclosures rather than qualitative disclosures. I provide a new insight by examining a different dimension of corporate disclosure that incorporates non-numerical and textual forms of reporting, namely the readability of annual reports.
The two previous chapters suggest that, overall, the readability of corporate disclosure can be strategically used by managers to alter users’ perceptions of the firm’s prospects. This means that the readability of corporate disclosures is generally associated with the ability of investors to monitor managers and limit their obfuscation behavior. In Chapter III, I investigate how financial reporting readability is affected in the presence of dual-class share structures, which are chiefly shown to be associated with lower information quality such that insiders having excess control rights can conceal their opportunistic behavior in pursuit of the private benefit of control (e.g., Fan and Wong, 2002; Francis et al. 2005; Lobanova et al. 2019). I follow the recent literature in this area of research, including Fan et al. (2017), Drago et al. (2018), Allaya et al. (2021), and Xu (2022), and suggest that insiders of dual-class firms would have incentives to increase annual report readability to preserve their long-term interests and reinforce their reputation in the market. This view may prevail in the U.S. economy, featuring strong investor protection and a highly transparent corporate informational environment, thus making the cost of information obfuscation markedly more expensive compared to other economies.
The primary contribution of this study is to pioneer the investigation of whether and how dual-class structures influence firm disclosure quality as measured by annual report readability. It might substantially contribute to the ongoing debate on the relevance of expanding dual-class structures in the U.S. economy or, instead, curtail and restrict the adoption of such equity patterns (Bebchuk and Kastiel, 2018; Jackson, 2018).
While the previous chapters contribute to the general understanding of key determinants of annual report readability, they are mostly limited to investigating the business environment of the firm and typically ignore its interactions with society. For the sake of completeness, Chapter IV examines a substantial antecedent of social norms, i.e., religiosity, on annual report readability. It is argued that informal institutional mechanisms such as religion are important vehicles and motivators for moral values in society, leading to self-regulation and self- monitoring of managers’ behavior, including that related to disclosure practices (Grullon et al., 2010; Conroy and Emerson, 2004; Longnecker et al., 2004; Pace, 2013). Therefore, highly religious managers are expected to help annual reports’ users make efficient decisions, notably by providing them with less complex and more readable information. This would lead to increased annual report readability in more religious firms.
The variable on religiosity for a given firm is measured annually as the number of religious adherents in the county in which that firm is headquartered, divided by the total population of the county. The number of religious adherents per county is obtained from ‘Religious Congregations & Membership in the United States files of 1990, 2000, and 2010. To complete religiosity data for missing years, I follow previous readability studies (Dyreng et al., 2012; El Ghoul et al., 2012) and perform a linear interpolation of data using, each time, religiosity data available for the previous and next points of time within which the studied year falls.
This last chapter offers new insights into the understanding of how religiosity plays in business ethics. To the best of my knowledge, it is the first study to investigate how corporate disclosure readability is affected by religious values. It also adds to the nascent literature on annual report readability by taking a broad stakeholder view rather than the restricted shareholder view. Taken together, the different research questions addressed in this thesis aim at broadening our understanding of corporate behavior vis-à-vis its disclosure policy. The variation in such behviour in firms from competitive markets, dual-class firms, and religious firms has not been investigated yet. This thesis fills this gap by examining annual report readability in these firms after a succinct overview of the literature on the key factors of corporate disclosure readability has been presented. These studies are conducted in the context of increased and more stringent corporate disclosure requirements and continual advances in computer text-mining tools. Besides considering the complexity of the disclosure environment, firms have to adapt their disclosure policies to competition intensity, ownership and control structure, and social and moral norms. This thesis is intended as a sustained reflection on these aspects in a comprehensive framework that involves interconnections of many areas of research.
This thesis is organized as follows. Chapter I presents a systematic review of the literature on corporate disclosure readability. Chapter II examines the effect of product market competition on annual report readability. Chapter III investigates annual report readability in dual-class and non-dual-class firms. Chapter VI explores the role of religiosity on annual report readability.
| Date of Award | 26 Jun 2024 |
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| Original language | English |
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| Supervisor | Khaled Hussainey (Supervisor) & Konstantinos Kallias (Supervisor) |