Determinants of Financial Statement Readability and its Impact on Corporate Policies

Abstract

Financial statements are the means through which the firms communicate their performance to the stakeholders. The financial statements offer information which is quantitative as well as qualitative in nature. Information is explained in a complex manner by the managers when the performance of the firm is poor (Bloomfield, 2002). Consistent with this notion, recent literature has cited the importance of textual information and its relation with the firm s overall performance (Ajina, 2016; Li, 2008; Lo et al., 2016). Readability measures the degree of difficulty in the text (Smith and Taffler, 1992). Understanding whether complex information is deliberately used by the managers to obfuscate information in the financial reports is an important question (Rutherford, 2005). Using the computational linguistic techniques, Li (2008) investigated the impact of readability on firms financial performance. The results showed that the firms with poor performance had annual reports which were more complex in nature while firms with good and persistent earnings had easier to read annual reports. Thus, the studies suggest that lesser readable reports reduce the confidence of the investors in making value relevant decisions (Alter and Oppenheimer, 2009) and, the ability to communicate effectively is reduced drastically. Most of the prior studies are conducted in the developed economies of the U.S. or the UK. The analysis of readability status of financial statements in the Indian market is an important question. The study-I of the thesis analyzes the impact of founder ownership on the readability of the Management Discussion and Analysis (MDandA) section of the annual report. We consider the Management Discussion and Analysis report as, MDandA also provides a unique opportunity for management to provide investors with an understanding of its view of the financial performance and condition of the company, an appreciation of what the financial statements show and do not show, as well as important trends and risks.