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.
IJAIM
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