T2: Guiding through the fog: Financial statement complexity and voluntary disclosure.

Question 1

Form 10-K?

Answer 1

Form 10-K: The Annual Report

• A strictly regulated and structured annual report, filed with the SEC.

Question 2

Form 8-K?

Answer 2

Form 8-K: Current Report (Ad-hoc communication)

• Notifications on important current events, filed with the SEC

Question 3

SFAS 133

Answer 3

• Accounting for Derivative Instruments and Hedging

* Effective for all fiscal quarters/years after June 15, 2000.

Question 4

SFAS 157

Answer 4

• Fair Value Measurements

* Effective for all fiscal quarters/years after November 15, 2007.

Question 5

What is the research question?

Answer 5

Research Question:
Do managers use voluntary disclosure to reduce complexity in information environments (annual reports)?

Motivating Question:
How do different disclosure channels interact?

Question 6

Why do we care?

Answer 6

Financial statement complexity is associated with various outcomes:

• lower trading volume and ownership among retail investors
• increased analyst forecast dispersion and reduced analyst forecast accuracy
• disagreement among credit rating agencies

Do managers try to mitigate these effects?

Question 7

Total uncertainty

Answer 7

Information uncertainty +Fundamental
uncertainty –>

Investors‘ average precision in predicting future CFs decreases —>

Increased voluntary disclosure

Question 8

What is the research method?

Answer 8

They “examine the relation between financial statement complexity and
voluntary disclosure by estimating regressions of the form:

where FS_Complexity is a measure of financial statement complexity,

VolDisc is a measure of voluntary disclosure,

and Controls is a vector of
control variables.”

Question 9

What is voluntary disclosure?

Answer 9

…is the number of management forecasts issued over the twelve months following the filing of the 10-K

• Respectively: the number of forecasts over the 90, 60, and 30 days after
the filing of the 10-K

• Robustness test: Press releases and 8-K filings

Question 10

How they measure complexity?

Answer 10

Readability:
• A combination of several readability measures
• Fog Index

Length:
• ln(number of words) in the 10-K

Question 11

What are the results?

Answer 11

The results suggest that firms provide more (and more timely) voluntary
disclosure when their financial statements are more complex.

Question 12

Which cross-sectional tests do the authors run?

Answer 12

Measures of Liquidity

External Monitoring

Firm Performance and Earnings Management

Timing

Question 13

What are the results of cross-sectional tests?

Answer 13

“Collectively, the results […] suggest that the positive relation between
financial statement complexity and voluntary disclosure is strongest in
settings where managers have greater incentives to mitigate the informational problems created by complex financial statements.”

Liquidity ↓      ↑ 
External monitoring ↑       ↑
Firm 
Performance ↓     ↓
Earnings
Management ↑↓

Question 14

Main question:

Do the results hold for an exogeneous shock to financial statement complexity?

Answer 14

The authors aim to:
• Validate the text-based measures
• Isolate the effects of reporting complexity on financial statement
complexity and voluntary disclosure
SFAS 133: Accounting for Derivatives SFAS 157: Fair Value Measurements

Question 15

Limitations

Answer 15

• Some results remain unexplained, e.g.,
– Table 4: Negative effect of change in illiquidity on voluntary
disclosure frequency. Why should managers only provide additional
information when financial statements are complex?

– Table 6: More earnings management seems to induce more
voluntary disclosure. Why should managers only hide information
when financial statements are complex?

• Are the results applicable to institutional investors?
• Proxies for complexity might not be perfect.
• Voluntary disclosure can be complex, too.
• Firms might use other forms of disclosure to mitigate negative effects.
• What about other stakeholders?