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Does annual report readability explain the accrual anomaly?

Ming Liu (Accounting, Saint Mary's University, Halifax, Canada)
Zhefeng Liu (Accounting, Brock University, St. Catharines, Canada)

Asian Review of Accounting

ISSN: 1321-7348

Article publication date: 28 May 2021

Issue publication date: 13 August 2021

417

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

Acknowledgements

This paper has benefited from discussions at the brown bag workshop of Brock University, 2019 Administrative Sciences Association of Canada (ASAC) and 2019 Canadian Academic Accounting Association (CAAA) annual conferences. This paper has also benefited from the reviewer comments of the 2019 ASAC and 2019 CAAA annual conferences. Last but not least, this paper has benefited from insightful comments of the associate editor (Dr. Wenxia Ge) and two anonymous referees.

Citation

Liu, M. and Liu, Z. (2021), "Does annual report readability explain the accrual anomaly?", Asian Review of Accounting, Vol. 29 No. 3, pp. 307-331. https://doi.org/10.1108/ARA-07-2020-0114

Publisher

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Emerald Publishing Limited

Copyright © 2021, Emerald Publishing Limited

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