Readability of 10-K Reports and Stock Price Crash Risk
Dr. Chansog KIM
College of Business
State University of New York at Stony Brook
This study examines whether firms issuing less readable annual reports are more prone to stock price crashes. In a setting of firm-level crashes, we answer the question whether managers hide bad news by obfuscating textual information in corporate disclosures. We create and validate a new set of readability indices tailored to the financial disclosure context, and find that crashes occur more frequently among firms using less readable text in 10-K filings. Further, the relation between annual report readability and stock price crash risk is more pronounced for firms without large-stake dedicated institutional investors. Our findings are consistent with the notion that managers withhold bad news by obfuscating textual information in annual reports. Additional analysis shows that firms prefer to obfuscate text in financial disclosures over earnings manipulation as the mechanism of withholding bad news after the passage of the Sarbanes-Oxley Act (SOX). This evidence highlights the importance of understanding corporate textual disclosures in the post-SOX era, echoing the Securities and Exchange Commission’s recent view that word analysis is useful in detecting managerial opportunistic behavior. Collectively viewed, our study contributes to the literature in terms of both theory and methodology, but also provides policy implications.