Annual reporting, agency costs, and firm valuations

• Author: Junwook Yoo,Igor Semenenko
• Date: 01 January 2020
• Published date: 01 January 2020
• DOI: http://doi.org/10.1002/jcaf.22419

BLIND PEER REVIEW

Annual reporting, agency costs, and firm valuations

Igor Semenenko

1

| Junwook Yoo

2

1

Acadia University, Wolfville, Nova

Scotia, Canada

2

California State University, Hayward,

California

Correspondence

Igor Semenenko, Acadia University,

15 University Ave, Wolfville, NS B4P 2R6,

Canada.

Email: igor.semenenko@acadiau.ca

Abstract

Shareholder valuations are economically significantly and statistically negatively

correlated with the length of 10 K filings or their digital file sizes, whereas annual

reports posted on corporate websites are uninformative. Firms with longer 10 K

filings are likely to experience slower growth, lower profitability, experience free

cash flow problems, and write off goodwill and intangible assets from past acqui-

sitions. Lengthy filings are more damaging than suggested by three-year perfor-

mance following report filing dates, suggesting that outside investors penalize

firms for information asymmetries and associated agency costs. Full disclosure is

best from the standpoint of long-term shareholder wealth, but managers could be

maximizing short-term term returns that better match their investment horizons.

KEYWORDS

10 K, agency cost, annual report, obfuscation, Q ratio

1|INTRODUCTION

While numerous studies have looked at various implica-

tions of level of complexity in financial reports, including

future stock returns (Doucette & Cohen, 2015) and cost

of capital (Ertugrul, Lei, Qiu, & Wan, 2017), none, to the

best of our knowledge, has examined direct valuation

effects. Three studies that come closest to ours in spirit

and focus are Li's (2008) and Subramanian, Insley, and

Blackwell (1993), both of whom document association

between higher profitability with lower readability mea-

sures, and Courtis (1986), who find no link between read-

ability and return on capital. However, none of them

measures impact on valuation multiples.

Using firm-year observations, this article documents

negative correlation between three metrics of annual fil-

ings length –10 K form length, annual report length, and

digital file size—and corporate valuation proxied by a Q-

ratio. The result is more pronounced for mandatory

filings—10 K forms—rather than annual reports, tenta-

tively suggesting negative impact of regulatory effects.

Large annual filings are associated with worse growth

prospects, write-offs of goodwill and intangible assets,

and free cash flow problems. This finding supports man-

agement obfuscation hypothesis, which postulates that

difficulty in reading can be by design and not in error—

managers have incentives to hide information when their

firms perform poorly (Baker & Kare, 1992; Bloomfield,

2002; Laskin, 2018). Interestingly, longer annual reports

appear to cause more damage than would be justified by

poor growth prospects and future profitability.

The organization of the article is as follows. The next

section reviews literature on annual filings readability

and outlines motivation for this study. It is followed by a

description of the data, discussion of results, and conclud-

ing remarks. Appendix A provides variables definitions.

2|MOTIVATION,

METHODOLOGY, AND DATA

DESCRIPTION

Existing body of academic evidence tentatively suggests

negative correlation between filings' complexity and valu-

ations (Morunga & Bradbury, 2013; Schick, Gordon, &

Haka, 1990; Snowball, 1980). Managers may intentionally

Received: 25 August 2019 Revised: 16 September 2019 Accepted: 19 September 2019

DOI: 10.1002/jcaf.22419

72 © 2019 Wiley Periodicals, Inc. J Corp Acct Fin. 2020;31:72–82.wileyonlinelibrary.com/journal/jcaf