Determinants of the Readability of SOX 404 Reports

Abstract

This study examines SOX 404 reports with fiscal year-ends between 2004 and 2014 to determine their readability as measured by the FOG Index. We investigate the association between readability and company characteristics, auditor type, opinion type, time period, report content, and report length. We find that the sign and significance of certain associations depend on whether the reports contain material weaknesses. Overall, results show that management's reports are more readable than auditor's reports; longer reports are more readable—contrary to findings for other corporate communications such as 10-Ks; reports of Big 6 firms are less readable than non-Big 6 reports. Interestingly, the Big 4 firms differed in the readability of their reports. Data Availability: Data are available from sources identified in the text.

Has it become more readable? Empirical evidence of key matters in independent audit reports,

“…Meanwhile, we also sought to control for firm size, by inserting the variables firm size (Size it ), operationalized using the natural logarithm of total assets, and firm age (Age it ), operationalized using the logarithm of the years the firm has been registered with the CVM, which is consistent with previous studies (Pinto et al, 2020;Velte, 2018Velte, , 2019. Less readability of the reports is expected as a result of firm size, this being due to the complexity of operations, which increases as the company "matures" and grows (Pinto et al, 2020;Boritz et al, 2016). However, while bigger companies are expected to have less readable reports, younger ones tend to strive to disclose more understandable reports.…”

“…According to Asay et al (2017), the increase in data may, in specific situations, hinder the readability of the text and cause an adverse effect on the parties involved, encouraging them to use other sources of information they are familiar with. Boritz et al (2016) verified that, unlike what has been observed in studies such as that of Dyer et al (2017), an increase in the size of the report does not necessarily reduce its readability, as users tend to be accustomed to the language used in such reports. In turn, Lo et al (2017) observed that the readability level of the reports is associated with the manipulation of accounting information, as companies with modified results tend to present more complex reports to conceal earnings management.…”

“…To analyze the research hypotheses, models 1, 2, and 3 were used, adapted based on the studies of Boritz et al (2016), Lo et al (2017), Pinto et al (2020), and Velte (2018.…”

“…ROE was calculated by dividing net income (NI) by net equity (NE). In both cases, in firms with better returns (ROE and Ri), managers are expected to engage less in publishing more readable reports (Boritz et al, 2016;Pinto et al, 2020;Velte, 2018).…”

“…The audit fees were operationalized using their natural logarithm in each firm-year, in line with the work of Segal (2019). With this, we sought to capture the greatest auditing risk and complexity of the work -a scenario from which a negative association is expected between audit fees and the FRI, as already observed by Boritz et al (2016). Following the same logic, we controlled the effect of the Big 4 auditing firms (DTT it , EY it , KPMG it , and PWC it ), which are generally hired by bigger and more complex companies.…”