Readability, governance and performance: a test of the obfuscation hypothesis in Qatari listed firms

• Pages: 270-298
• DOI: https://doi.org/10.1108/CG-05-2018-0182
• Date: 10 October 2018
• Published date: 10 October 2018
• Author: Mostafa Kamal Hassan,Bassam Abu Abbas,Samy Nathan Garas
• Subject Matter: Corporate governance,Strategy

Readability, governance and performance:

a test of the obfuscation hypothesis in

Qatari listed f‌irms

Mostafa Kamal Hassan, Bassam Abu Abbas and Samy Nathan Garas

Abstract

Purpose –This paper aims to examine the relationship between the readability of annual reports and

corporateperformance in Qatari listed firmswhile controlling for a firm’s competitiveposition, governance

structureand specific features such as size,age and industry type.

Design/methodology/approach –This study relies on both agency theory and legitimacy theory to

develop testable hypotheses. It uses a sample of 126 firm-year listed companies in the Qatar Stock

Exchange to test obfuscation in the annual reports through examining the association between the

readability of NarrativeDisclosures (NDs) and corporate profitability, financial risk and agencycosts for

the periodfrom 2014-2016.

Findings –The findings show that firms with higher annual report readability are mor e profitable and have

lower agency costs, which is an indication of the existence of ‘‘obfuscation.’’ Qatari f irms may use narrative

complexity as a disclosure strategy to enhance their image and consequently maintain their soci al legitimacy.

Research limitations/implications –Although the study findings suffer from limited global

generalization, they can be generalized across Gulf Cooperation Council countries. Thus, future cross-

countryresearch is encouraged.

Practical implications –The findings encourage Qatari policymakers to instate a policy for ‘‘Plain

English’’writing to make NDs easy to read by internationalinvestors.

Originality/value –This study is oneof very few studies that examinesthe readability of annual reports in

emerging market economies,i.e. Qatar. The study contributes to the paucity of research that examines

English-writtenannual reports in non-Englishspeaking countries.

Keywords Agency theory, Corporate performance, Legitimacy theory, Readability

Paper type Research paper

1. Introduction

With the increase of required information in annual reports related to a firm’s social

responsibility, risk management and sustainability, accounting narratives are becoming

increasingly important in external reporting (Clatworthy and Jones, 2001). Narrative

disclosures (NDs) have grown in importance over the past few years (Jones and Smith,

2014). They incorporate rich content describing, discussing and evaluating the firm’s

financial and non-financial performance and its competitive position. NDs provide

management with opportunities to explain and reveal some of the underlying reasons

behind the firm’s performance, productivity, comparative advantages and competitiveness.

In fact, NDs set the context for the annual reports and therefore must be effectively

communicated to the firm’s stakeholders.Smith and Taffler (1992b) argue that NDs must be

an effective medium of communication so that users of annual reports correctly and

precisely understand the intended message sent by the preparers of these reports.

Therefore, effective communication is an essential element if NDs are to be understood.

Mostafa Kamal Hassan is

Professor at the

Department of Accounting

and Information Systems,

College of Business and

Economics, Qatar

University, Doha, Qatar.

Bassam Abu Abbas is

based at the Department of

Accounting and Information

Systems, College of

Business and Economics,

Qatar University, Doha,

Qatar.

Samy Nathan Garas is

based at the Department of

Accounting, SUNY

Plattsburgh, Plattsburgh,

New York, USA.

Received 21 May 2018

Revised 28 August 2018

11 September 2018

Accepted 12 September 2018

PAGE 270 jCORPORATE GOVERNANCE jVOL. 19 NO. 2 2019, pp. 270-298, ©Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-05-2018-0182

Prior studies examining effective communication of NDs are split into two streams: some

focus on the reading difficulty of annual reports and address the question of “how difficult

are annual reports to read?” (Jones and Shoemaker, 1994), whereas others test the

association between reading ease and financial performance and produce contradictory

results (Smith and Taffler, 2000;Clatworthy and Jones, 2001;Hrasky and Smith, 2008).

Furthermore, prior studies on the readability of annual reports either used the Chairman’s

Statement (Courtis, 1998;Smith et al.,2006), management review (Hossain and Siddiquee,

2008), management discussion and analysis (Schroeder and Gibson, 1992;Ginesti et al.,

2017) or a letter to the stockholders (Subramanianet al.,1993). These studies also examine

the readability of annual reports in countries such as Italy (Ginesti et al.,2017), Australia

(Hrasky and Smith, 2008) and the UK (Jones, 1988). However, none of the prior studies

examined the effect of annual reports’ readability on firms’ financial performances in

emerging market such as Qatar. Our study addresses this research gap and examines the

association between readability and a firm’s financial measures (measured by profitability,

risk and agency problems) while controlling for the firm’s competitive position, governance

structure, size and age.

Another major feature of prior studies is that they focused attention on testing the effect of

the firm’s financial performance on the annual report’s readability (Smith and Taffler, 1992a;

Subramanian et al., 1993;Clatworthy and Jones, 2006;Hrasky et al.,2009). Therefore, one

of our study contributions is that it tests the effect of readability on the firm’s financial

performance. This reverse causality highlights the importance of the readability of annual

reports and reveals the underlyingmanagerial motives behind the utilization of easy, difficult

or complex NDs. It also highlights how corporate managers may use NDs for their interests

and/or obtain social legitimacy,despite the regulatory context in which listed firms operate.

Our study primarily focuses on readability and obfuscation in annual reports published by

firms operating in one of the emerging economic countries, i.e. the State of Qatar. This

study contributes to prior studies because it first measures the reading difficulty of NDs

incorporated in the annual reports of one of the emerging market economies (Qatar). It also

contributes to a paucity of research that examines English-written annual reports in non-

English speaking countries (Jeanjean et al.,2015;Lundholm et al.,2014). Second, it tests

the obfuscation hypothesis wherein the State of Qatar listed firms attempt to obscure

negative information behind complex textual structures, while positive information is

highlighted through easy to read language (Courtis, 1998;Smith et al.,2006;Li, 2008;

Melloni et al., 2017). Accordingly, our study findings illustrate insights related to NDs in a

less researched area in emerging economies and contribute to enhancing NDs not only in

Qatar but also in neighbor countries that share similar social, political and economic

characteristics. Finally, the paper uses two different readability tests (the Flesch Reading

Ease score and the Flesch–Kincaid grade level score) to corroborate our study findings.

Our study findings illustrate the tendency of Qatar listed firms to use obfuscation, as the

empirical results show significant positive associations between readability scores (i.e.

easier to read annual reports) and a firm’s profitability (measured by ROA), a firm’s agency

costs (measured by assets utilization) and a negative insignificant relationship with a firm’s

risk (measured by debt to assets).

Our study is motivated by a lack of empirical evidence regarding the textual complexity of

corporate report narratives in an emerging market setting (the State of Qatar). NDs have

become an important part of disclosure regulations worldwide (Hrasky et al., 2009) and the

State of Qatar is no exception. For example, the Australian Corporations Act of 2004

requires managers of listed firms to incorporate sufficient information addressing the firm’s

strategies and its prospects. Likewise, article 146 of the Commercial Companies Law No.

11 of 2015 in the State of Qatar requires managers of listed firms to prepare annual reports

in accordance with International Financial Reporting Standards (IFRS) while revealing the

reasons for noncompliance. Furthermore, Qatar Financial Markets Authority listing

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