Political Corruption and Annual Report Readability: Evidence from the United States

Abstract

This study examines the association between the political corruption of a local government and the readability of firms’ annual reports. Based on a sample of 12,742 firm-year observations (for 2,369 unique firms) during the 2006-2014 period and the Gunning Fog Index as the primary measure of annual report readability, the study reveals that firms located in more corrupt regions tend to disclose less readable financial reports. Our additional analyses reveal that the level of annual report readability is lower for firms located in more corrupt regions, regardless of the firms’ level of return on assets. We also find that firms located in more corrupt regions and having more able managers are more likely to obfuscate firms’ information in annual reports than other firms. The results imply firms’ effort to minimize rent extraction from corrupt government officials. A further test shows that firms in more corrupt regions are more likely to report less readable Management Discussion and Analysis (MD&A) section of annual reports. This paper extends the prior literature on annual report readability and political corruption. The paper also provides additional evidence to the mixed results on the management’s obfuscation behavior related to the readability of financial disclosures. The findings may be of interest to regulators seeking out factors influencing firms’ readability of annual reports.

Keywords: Political Corruption, Annual Report Readability, Gunning Fog Index