Culture and annual report readability

• DOI: https://doi.org/10.1108/IJAIM-05-2021-0094
• Published date: 16 August 2021
• Date: 16 August 2021
• Pages: 583-602
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Minyoung Noh

Culture and annual report

readability

Minyoung Noh

California State University Los Angeles, Los Angeles, California, USA

Abstract

Purpose –This study aims to examine the effectof state culture on the readability of narrative disclosures

in annual reportsbased on f‌irms located in all 50 states of the USA.

Design/methodology/approach –The authoruses the cultural tightness and looseness(Harrington and

Gelfand 2014)index at the state level and the BOG index (Bonsall and Miller, 2017) as the primary measures of

annual reportreadability.

Findings –Using US data from 1994 to 2019, this study f‌inds that the state level of cultural tightness in

which f‌irms are locatedpositively affects f‌irms’annual report readability. In addition,the study f‌inds that the

positive effect of cultural tightness on annual report readability is pronounced in subgroups with high

litigation risk while the result does not hold with subgroups that have low litigation risk. The results are

robust when alternativeproxies for annual report readability are used and historical locationand the states in

which f‌irmsare incorporated are considered.

Originality/value –This study contributes to the growingliterature on the determinants of readability in

annual report because f‌irms’narrative disclosure in annual report varies depending on the information

environment,litigation risk, embedded in each state culturewhere f‌irms are located.

Keywords Cultural tightness-looseness, Uncertainty avoidance, Litigation risk,

Annual report readability

Paper type Research paper

1. Introduction

The textual information in an annual report is a key channel for communicating with

different stakeholders. As stakeholders rely on information in an annual report [1]to

interpret f‌irms’current and future prof‌itability and exposure to risk, it is important to

discern how disclosed informationis understood by users. Also, regulators and professional

accounting organizations [2] emphasize the importance of plain English and readability in

f‌inancial disclosures. Therefore, it is important to identify the elements that inf‌luence the

narrative disclosure of an annual report. As the determinant of the readability of such

disclosures, the surrounding environment –for example, the international differences in

institutional environments(Lang and Stice-Lawrence, 2015)[

3] and national culture (Kumar,

2014)[

4]–may affect the readabilityof annual reports. As such, the readability of an annual

report is expected to mirror the predominant cultural inf‌luences found in that society. Yet

little research has shownwhether such a relationship exists given cultural differencesacross

the USA. Unlike prior studies, I shift the focus on how statewide cultural tightness and

looseness (measured with the CTL Index developed by Harrington and Gelfand, 2014)

affects annual reportreadability (measured with the Bog Index (BOG),developed by Bonsall

and Miller, 2017), based on US-listed companies. Moreover, the threat of litigation in each

state can serve as a critical restrictionon readability since information transmission may be

affected by harsh or forgiving legal environments. These environments are embedded in

each state’s culture, forcing f‌irms to adopt to either enhance or reduce readability in their

Culture and

annual report

readability

583

Received10 May 2021

Revised12 June 2021

Accepted20 June 2021

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 4, 2021

pp. 583-602

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-05-2021-0094

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

annual reports. I provideevidence that shows that a tight culture enhancesthe readability of

an annual report, and litigation risk reinforces the association between a tight culture and

readability. These f‌indings imply that f‌irms’narrative disclosure in annual reports can be

affected by cultural differences across the states in which f‌irms are located and this

relationship dependson litigation risk that f‌irms face.

In this paper, I pose the followingtwo research questions. First, is cultural tightness and

looseness (CTL) at the state level [5] related to the readability of an annual report? Second,

does litigation risk moderate or reinforce the association between CTL and annual report

readability? Firms that are clustered in a country or in a geo-political division (e.g. the US

versus Europe) or at the state level exhibit variouscultural differences. Increasingly, culture

has become an important determinant for both f‌inancial outcomes and f‌inancial reporting

because culture inf‌luences the institutional environment, including the political system,

capital markets and the legal system.For example, culture affects the corporate governance

structure of f‌irms within a country (Licht et al., 2005;Doidge et al.,2007), as well as

international investment f‌low (Siegel et al.,2011) and individual’s foreign investment

decisions (Beugelsdijk and Frijns, 2010;Anderson et al., 2011). Evaluating how different a

culture in one state may be from that in another state is relevant for f‌irms facing specif‌ic

local criteria in f‌inancial reporting. Prior studies have identif‌ied various determinants of

annual report readability, such as business strategy, earnings management and poor

performance at the f‌irm level (Habib and Hasan, 2020;Lim et al.,2018;Lo et al.,2017;Li,

2008). Also, narrative disclosure in annual reports varies with the foreign stock exchange

disclosure requirement (Lundholm et al., 2014), the institutional environment (Lang and

Stice-Lawrence, 2015) and national culture(Kumar, 2014). However, the extent to which the

readability of disclosure narrativesis related to state-level cultural differences, particularly

CTL, remains unexplored.

Prior research on CTL ref‌lects the strength of norms and views within companies

depending on where they are located (Gelfand et al.,2006;Harrington and Gelfand, 2014).

Tight culture is associated with higher trait conscientiousness, more exposure to ecological

vulnerability, and, thus, a high level of uncertainty avoidance (Gelfand et al., 2006;

Harrington and Gelfand, 2014). The linkage between CTL and readability can be explained

by uncertainty avoidance. In uncertainty-avoiding cultures, people are more anxious about

threats and therefore tend to take immediate reaction to lessen ambiguity (Hofstede, 2001).

This anxiety that threatens their respective comfortzones can be resolved with a high level

of uncertainty avoidance in tight cultures. Therefore, in a tight culture, a greater need to

reduce uncertainty arises since individuals seek information to reduce their level of

discomfort when facedwith uncertain situations. As such, in tight cultures,individuals trust

clear procedures and well-understood guidelines to manage their discomfort when

confronted with unfamiliar circumstances (Hofstede, 1980). Thus, their annual reports are

likely to be written with structuredand unambiguous sentences. In contrast, the tolerance of

anxiety is quite high in a loose culture because unfamiliar situations are welcomed, and a

greater degree of different approaches is allowed. Therefore, in a loose culture, greater

f‌lexibility exists with a diverse set of information, which makes it diff‌icult for members to

identify when uncertainty-avoidanceaction is needed. Therefore, low uncertainty-avoidance

cultures react insignif‌icantly to public information. Therefore, I expect that loose culture

drives f‌irms’annual reports to be less readable and more ambiguous about incorporating

different perspectives.Based on the above, I argue that tight culture is positively associated

with the readability of f‌irms’annualreports, in context, given that practical and executable

solutions in response to uncertaintymust be encountered.

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