Measuring Firm Complexity

43 Pages Posted: 15 Jul 2020 Last revised: 20 Jul 2020

See all articles by Tim Loughran

Tim Loughran

University of Notre Dame

Bill McDonald

University of Notre Dame - Mendoza College of Business - Department of Finance

Date Written: July 9, 2020

Abstract

In business research, firm size is both ubiquitous and readily measured. In contrast, complexity, another firm-related construct, is frequently relevant, but difficult to measure and not well defined. As a result, complexity is seldom incorporated in empirical designs. Measures such as the number of firm segments or the readability of a firm’s financial filings are often used as proxies for some aspect of complexity. We argue that most extant measures of complexity are misspecified, one-dimensional, and/or not widely available. We propose a text-based solution as a widely available, omnibus measure of this multidimensional concept and use audit fees—which are well established as being largely driven by size and complexity—as the primary empirical framework for evaluation. Because this is a new measure, we also consider alternative contexts, including returns around 10-K filings, initial public offerings, unexpected earnings, and the COVID-19 crisis.

Keywords: firm complexity, audit fees, textual analysis, Form 10-K, unexpected earnings, IPO returns, COVID-19

JEL Classification: D82, D83, G14, G18, G30, M40, M41

Suggested Citation

Loughran, Tim and McDonald, Bill, Measuring Firm Complexity (July 9, 2020). Available at SSRN: https://ssrn.com/abstract=3645372 or http://dx.doi.org/10.2139/ssrn.3645372

Tim Loughran (Contact Author)

University of Notre Dame ( email )

Department of Finance
245 Mendoza College of Business
Notre Dame, IN 46556-5646
United States
574-631-8432 (Phone)
574-631-5255 (Fax)

Bill McDonald

University of Notre Dame - Mendoza College of Business - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

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