Does annual report readability explain the accrual anomaly?

Ming Liu and Zhefeng Liu

Asian Review of Accounting, 2021, vol. 29, issue 3, 307-331

Abstract: Purpose - The purpose of the study is to investigate the possible role of annual report readability in accrual anomaly, shedding light on why investors fail to incorporate accruals information in a timely and unbiased manner beyond the original naive investor fixation explanation. Design/methodology/approach - Using five proxies of annual report readability and available data over 1993–2017, we investigate whether accrual overpricing is more severe when annual reports are less readable. Findings - We find little (substantive) evidence of accrual overpricing among high (low) readability firms. The readability effects are contingent on the level of business complexity and earnings management. Research limitations/implications - This study extends the original naive investor fixation explanation and documents annual report complexity as a market friction in explaining the accrual anomaly, contributing to the mispricing vs risk debate and supporting the efficient market hypothesis. Practical implications - Low readability of annual reports is a red flag to investors. Social implications - This study provides support for regulatory initiatives aimed at enhancing readability of corporate disclosures to address market frictions and improve market efficiency. Originality/value - Accrual anomaly has posed a challenge to the efficient market hypothesis. This study draws on and adds to the line of research indicating that annual report complexity is a friction erecting a barrier to transparency, hindering market efficiency. This study contributes to our understanding of the enigmatic accrual anomaly.

Keywords: Accrual anomaly; Business complexity; Earnings management; Textual analysis; Readability; Complexity; Fog index (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eme:arapps:ara-07-2020-0114

DOI: 10.1108/ARA-07-2020-0114

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