Measures of the earnings construct
|
Persistence |
Estimate of the coefficient of inclination β1i based on the model presented in equation 4. This is the first-order autoregressive model (AR1) estimated for every company-year using 7-year windows. (4)
|
Concept: A positive relationship is expected between the Persistence measure and the readability variables. Earnings per share is understood as the values of profit or loss per share. The interpretation of eq. 4 is that the higher β1i values indicate high persistence and values close to 0 indicate transitory performance or low persistence. Note that the choice of analysis window follows the research of Francis et al. (2004Francis, J., LaFond, R., Olsson, P. M., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review, 79(4), 967-1010. https://doi.org/10.2308/accr.2004.79.4.967 https://doi.org/10.2308/accr.2004.79.4.9...
), who opted to employ a 10-year window. In this research, a 7-year window is preferred, because we chose to employ a balanced data panel. Thus, by choosing a bigger window of years, the final sample is substantially reduced, as was observed in unreported tests, which would hinder the statistical inferences. The procedure for calculating persistence by estimating an autoregressive model followed the studies of Barton, Hansen, and Pownall (2010Barton, J., Hansen, T. B., & Pownall, G. (2010). Which performance measures do investors around the world value the most-and why? The Accounting Review, 85(3), 753-789. https://doi.org/10.2308/accr.2010.85.3.753 https://doi.org/10.2308/accr.2010.85.3.7...
) and Francis et al. (2004Francis, J., LaFond, R., Olsson, P. M., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review, 79(4), 967-1010. https://doi.org/10.2308/accr.2004.79.4.967 https://doi.org/10.2308/accr.2004.79.4.9...
). Unlike the present study, which employs Earnings per share, Barton et al. (2010Barton, J., Hansen, T. B., & Pownall, G. (2010). Which performance measures do investors around the world value the most-and why? The Accounting Review, 85(3), 753-789. https://doi.org/10.2308/accr.2010.85.3.753 https://doi.org/10.2308/accr.2010.85.3.7...
) use a composite earnings variable and Francis et al. (2004Francis, J., LaFond, R., Olsson, P. M., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review, 79(4), 967-1010. https://doi.org/10.2308/accr.2004.79.4.967 https://doi.org/10.2308/accr.2004.79.4.9...
) employ a measure of net income before extraordinary items. To identify possible econometric problems, the augmented Dickey-Fuller test was applied (Said & Dickey, 1984Said, S. E., & Dickey, D. A. (1984). Testing for unit roots in autoregressive-moving average models of unknown order. Biometrika, 71(3), 599-607. https://doi.org/10.1093/biomet/71.3.599 https://doi.org/10.1093/biomet/71.3.599...
). The procedure was carried out with the test equation with trend, with drift, and with a 1-period lag, as discussed by Gujarati and Porter (2011Gujarati, D. N., & Porter, D. C. (2011). Econometria básica (5a ed.). Editora AMGH.). Initially, the test was conducted by company for all the data windows, from 2000 to 2019. At this stage it was not possible to reject H0 for 12 companies, that is, 12 companies presented a non-stationary data series. To test the effect of this violation of the property of a series, the observations were excluded from the sample and the parameters of model (1) were re-estimated. As there were no discrepancies in relation to the original values, we chose to maintain the observations in the database. Subsequently, the augmented Dickey-Fuller test was conducted by company-year using 7-year windows, which resulted in 14 statistics for the test by company. As before, the companies that presented a non-stationary data series were excluded from the sample of companies and the parameters of model (1) were re-estimated. As no significant changes occurred in the estimate of the parameters, the companies were maintained in the sample. |
Performance |
= EBIT / Total assets |
Concept: The Performance proxy captures accounting performance. A positive relationship is expected between the Performance measure and readability. The operationalization of the variable is in accordance with Li (2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
) and Lo et al. (2017Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25. https://doi.org/10.1016/j.jacceco.2016.09.002 https://doi.org/10.1016/j.jacceco.2016.0...
). |
Benchmark |
= 1 if the variable for Performance from year +1 to year t1 is negative, or 0 otherwise. |
Concept: a negative relationship is expected with the readability measures, indicating that companies that did not achieve the reference benchmark in relation to the previous year tend to disclose more complex reports. This variable is in accordance with the one presented by Li (2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
) and Lo et al. (2017Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25. https://doi.org/10.1016/j.jacceco.2016.09.002 https://doi.org/10.1016/j.jacceco.2016.0...
). |
Measure of harmonization with IFRS
|
IFRS |
= 1 if the observation belongs to the post-IFRS period (≥ 2010), or 0 otherwise |
Concept: In Brazil, the main milestone of the IFRS convergence process was the enactment of Law n. 11,638/2007Lei 11.638, de 28 de setembro de 2007. (2007). Altera e revoga dispositivos da Lei n. 6.404, de 15 de dezembro de 1976, e da Lei n. 6.385, de 7 de dezembro de 1976, e estende às sociedades de grande porte disposições relativas à elaboração e divulgação de demo. http://www.planalto.gov.br/ccivil_03/_ato2007-2010/2007/lei/l11638.htm http://www.planalto.gov.br/ccivil_03/_at...
. The approach of distinguishing harmonization with IFRS is in accordance with the studies of Boubaker et al. (2019Boubaker, S., Gounopoulos, D., & Rjiba, H. (2019). Annual report readability and stock liquidity. Financial Markets, Institutions and Instruments, 28(2), 159-186. https://doi.org/10.1111/fmii.12110 https://doi.org/10.1111/fmii.12110...
) and of Cheung and Lau (2016Cheung, E., & Lau, J. (2016). Readability of notes to the financial statements and the adoption of IFRS. Australian Accounting Review, 26(2), 162-176. https://doi.org/10.1111/auar.12087 https://doi.org/10.1111/auar.12087...
). A positive result is expected for the variable, because harmonization with IFRS can add an incremental improvement in the informational environment. |
Control variables
|
Liquidity |
|
Where: p = number of days on which there was at least one trade with the share within the chosen period P = total number of days of the chosen period n = number of trades with the share within the chosen period N = number of trades with all the shares within the chosen period v = financial volume with the share within the chosen period V = financial volume with all the shares within the chosen period |
Concept: Bloomfield and Wilks (2000Bloomfield, R. J., & Wilks, T. J. (2000). Disclosure effects in the laboratory: liquidity, depth, and the cost of capital. The Accounting Review, 75(1), 13-41. https://www.jstor.org/stable/248631 https://www.jstor.org/stable/248631...
) and Heflin, Shaw, and Wild (2005Heflin, F. L., Shaw, K. W., & Wild, J. J. (2005). Disclosure policy and market liquidity: impact of depth quotes and order sizes. Contemporary Accounting Research, 22(4), 829-865. https://doi.org/10.1506/eetm-falm-4kdd-9dt9 https://doi.org/10.1506/eetm-falm-4kdd-9...
) argue that an improvement in disclosure increases the demand for shares, with a resulting increase in their liquidity. Boubaker et al. (2019Boubaker, S., Gounopoulos, D., & Rjiba, H. (2019). Annual report readability and stock liquidity. Financial Markets, Institutions and Instruments, 28(2), 159-186. https://doi.org/10.1111/fmii.12110 https://doi.org/10.1111/fmii.12110...
) and Lang and Stice-Lawrence (2015Lang, M., & Stice-Lawrence, L. (2015). Textual analysis and international financial reporting: large sample evidence. Journal of Accounting and Economics, 60(2-3), 110-135. https://doi.org/10.1016/j.jacceco.2015.09.002 https://doi.org/10.1016/j.jacceco.2015.0...
) are examples of studies that empirically test this relationship. And a positive sign is expected of the liquidity proxy when related to readability. |
Size |
= ln of Total assets |
Concept: Bigger companies tend to be more complex, both operationally and geographically (Dempsey et al., 2012Dempsey, S. J., Harrison, D. M., Luchtenberg, K. F., & Seiler, M. J. (2012). Financial opacity and firm performance: the readability of REIT annual reports. Journal of Real Estate Finance and Economics, 45(2), 450-470. https://doi.org/10.1007/s11146-010-9263-2 https://doi.org/10.1007/s11146-010-9263-...
). Such complexity may be reflected in the readability of their reports, because bigger companies issue more complex reports (Ajina et al., 2016Ajina, A., Laouiti, M., & Msolli, B. (2016). Guiding through the Fog: does annual report readability reveal earnings management? Research in International Business and Finance, 38, 509-516. https://doi.org/10.1016/j.ribaf.2016.07.021 https://doi.org/10.1016/j.ribaf.2016.07....
; Dempsey et al., 2012Dempsey, S. J., Harrison, D. M., Luchtenberg, K. F., & Seiler, M. J. (2012). Financial opacity and firm performance: the readability of REIT annual reports. Journal of Real Estate Finance and Economics, 45(2), 450-470. https://doi.org/10.1007/s11146-010-9263-2 https://doi.org/10.1007/s11146-010-9263-...
; Li, 2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
; Lo et al., 2017Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25. https://doi.org/10.1016/j.jacceco.2016.09.002 https://doi.org/10.1016/j.jacceco.2016.0...
). The sign expected for the size variable is negative. |
Volatility |
= Standard deviation of the Performance variable (EBIT / Total assets) for a 5-year window. |
Concept: It is assumed that, in more volatile business environments, corporate communication is more complex (Li, 2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
). Thus, a negative sign is expected for this variable. Cheung and Lau (2016Cheung, E., & Lau, J. (2016). Readability of notes to the financial statements and the adoption of IFRS. Australian Accounting Review, 26(2), 162-176. https://doi.org/10.1111/auar.12087 https://doi.org/10.1111/auar.12087...
), Li (2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
), and Lo et al. (2017Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25. https://doi.org/10.1016/j.jacceco.2016.09.002 https://doi.org/10.1016/j.jacceco.2016.0...
) are examples of studies that use this variable. |
Indebtedness |
= (Current liabilities + Non-current liabilities) / Total assets |
Concept: Companies with a high level of debts may publish more complex reports, with the aim of persuading capital providers (Dempsey et al., 2012Dempsey, S. J., Harrison, D. M., Luchtenberg, K. F., & Seiler, M. J. (2012). Financial opacity and firm performance: the readability of REIT annual reports. Journal of Real Estate Finance and Economics, 45(2), 450-470. https://doi.org/10.1007/s11146-010-9263-2 https://doi.org/10.1007/s11146-010-9263-...
). A negative relationship is expected between indebtedness and readability as in Ajina et al. (2016Ajina, A., Laouiti, M., & Msolli, B. (2016). Guiding through the Fog: does annual report readability reveal earnings management? Research in International Business and Finance, 38, 509-516. https://doi.org/10.1016/j.ribaf.2016.07.021 https://doi.org/10.1016/j.ribaf.2016.07....
) and Dempsey et al. (2012Dempsey, S. J., Harrison, D. M., Luchtenberg, K. F., & Seiler, M. J. (2012). Financial opacity and firm performance: the readability of REIT annual reports. Journal of Real Estate Finance and Economics, 45(2), 450-470. https://doi.org/10.1007/s11146-010-9263-2 https://doi.org/10.1007/s11146-010-9263-...
). |
Age |
= ln of the difference, in days, from the date the company was founded to the closing date of the financial statements |
Concept: Companies in operation for longer may present less complex reports due to the greater asymmetry and uncertainty in their information (Li, 2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
). This variable was used by Li (2008Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 https://doi.org/10.1016/j.jacceco.2008.0...
) and Lo et al. (2017Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25. https://doi.org/10.1016/j.jacceco.2016.09.002 https://doi.org/10.1016/j.jacceco.2016.0...
). |
Variables used in the additional tests
|
Low Persistence |
Observations found in the first two quintiles (Q2/5) of the Persistence variable |
High Persistence |
Observations found in the last two quintiles (Q4/5) of the Persistence variable |
Low Performance |
Observations found in the first two quintiles (Q2/5) of the Performance variable |
High Performance |
Observations found in the last two quintiles (Q4/5) of the Performance variable |
Ranking |
The Ranking variable takes the value of 1 if the company belongs to the last two quintiles (Q4/5) of the readability ranking and 0 if it belongs to the first two quintiles (Q2/5). |
The readability ranking is captured after multiplying the percentages of shared variance, obtained from the factor loadings of the textual characteristics ModFlesch, ModFog, and Simple Writing. |