Does readability affect the value relevance of accounting information?
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School of Business | Master's thesis
AbstractGeneral purpose of financial reporting according to Financial Accounting Standards Board (FASB) is to provide information to investors and other stakeholders that is useful in making economic decisions. Information has to be relevant and faithfully represented in order for it to be useful. Value relevance studies are one way of operationalizing these requirements for relevance and reliability. An accounting amount is said to be value relevant if it has a significant association with company share price. Market efficiency measures how well the available relevant information is reflected in share prices. Two factors may affect this efficiency: the costs of information processing and the information asymmetry. Information processing costs arise e.g. from detecting, gathering, compiling and processing data, or hiring others to do so. Information asymmetry means that management has more information about the company than investors. I argue that poor readability of annual reports may cause both higher information processing costs and higher information asymmetry. For decades now the US Securities and Exchange Commission (the SEC) has paid attention to companies’ disclosures’ readability. The SEC published a Plain English Handbook to advise financial disclosure authors in creating more readable disclosures. There are many definitions of readability, but a common nominator for these definitions is that they explain readability through reader’s ease of understanding. In this thesis, I will first test whether net income and book value of equity contain value relevant information. Secondly, I will test whether the readability of annual report affects the value relevance of these variables. The test results confirm that both net income and book value of equity contain value relevant information, and that low readability has a negative effect on their value relevance.
Thesis advisorJarva, Henry
readability, value relevance, market efficiency, book value of equity, earnings, bog index