Annual Report Readability, Firm Performance, and Earnings Management

This paper investigates the association between annual report readability and firm performance and earnings management. The readability of annual reports is measured with four proxies including Gunning fog index, Korean language index, accounting fog index, and word count index where the high indexes of readability show lower readability except for Korean language index. When firm performance is measured with loss firm, earnings, and negative earnings change, loss firm and earnings are negatively associated with readability. This result indicates that firms with higher earnings tend to provide easy readable annual reports. Then, in the test of the association between readability and earnings management which is measured with three proxies including accrual earnings management, absolute accrual earnings management, and real earnings management, absolute earnings management and real earnings management have a significant and negative association with accounting fog index. The negative association of absolute earnings management indicates that the firms with larger earnings management are likely to provide easy readable annual reports. The negative association of real earnings management indicates that the firms with positive real earnings management are likely to provide easy readable annual reports. Overall, the results support the obfuscation theory that when firm performance is poor or earnings management is carrying out negatively, firms are likely to provide less readable annual reports.