The Effect of Accounting Reporting Complexity on Financial Analysts

Abstract

We investigate the association between a new XBRL based measure of accounting reporting complexity (ARC) and analyst behavior. We find that analysts are less likely to cover firms with complex accounting. Further, higher ARC is associated with lower forecast accuracy, higher forecast dispersion, and lower informativeness of recommendation revisions and responsiveness to earnings announcements. This association is attenuated when analysts have longer tenure, greater firm-specific experience, and are focused on fewer industries. Investigating several complex accounts, we find that the complexity of derivatives, fair value, and pension accounts are each negatively associated with forecast accuracy, suggesting that understanding these complex accounts requires specialization. We propose a new measure of analysts' account-specific expertise and find that expertise with derivative and fair value accounts attenuates the negative effects of complexity in these accounts to a greater extent than general analyst experience. Overall, our findings suggest that analysts' expertise plays an important role in mitigating the adverse effects of ARC. JEL Classification: G24, G29, M41Keywords: XBRL, accounting complexity, financial analysts' performance, financial analysts' expertise Data Availability: Data are publicly available from sources identified in the paper. 1 The Effect of Accounting Reporting Complexity on Financial Analysts I. IntroductionRegulators and standard setters have long recognized that financial reporting has become overly complicated (SEC 2008; FRC 2009). As a result, the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) undertook several initiatives to understand and simplify the financial reports (e.g. SEC 2008; FASB 2016). In this study, we examine how accounting reporting complexity (hereafter, ARC), measured as the count of accounting items disclosed in eXtensible Business Reporting Language (XBRL) 10-K filings, is associated with financial analysts' performance and coverage decisions. Since each accounting item is based on authoritative standards and regulations, understanding the financial reports of firms with higher ARC necessitates broader and more in-depth knowledge of accounting.While Hoitash and Hoitash (2017) find that more accounting disclosure complicates the work of preparers and auditors, it is unclear how disclosure volume will be associated with the work of sophisticated market participants such as financial analysts. Greater volume of accounting disclosures can help analysts understand past performance and generate more accurate forecasts.Indeed, several studies find that more disaggregated disclosures can lead to better analyst performance (Lang and Lundholm 1996;Chen et al. 2015). In contrast, more disclosure requires greater knowledge of accounting rules and regulations on part of financial analysts and a need to collect, analyze, and incorporate more information into their predictions. As a result, ARC may hurt overall analyst perfor...

Annual Report Complexity and Firm Profitability: The Roles of Agency Costs and Financial Risk as Moderating Variables: A Case of Egypt

“…The complexity of annual reports has received more attention from the capital market (Luo et al, 2018;). Annual report complexity has been found to increase the time, cost, and effort that users of financial information need to understand, interpret, and evaluate a company's performance (Hoitash et al 2017). The impact of annual reports complexity on agency costs, financial risk and firm profitability is unclear .…”

“…It also helps users understand, evaluate, and analyze a company's performance. In this context, Hoitash et al (2017) examined the relationship between annual report complexity and analysts' behavior for a sample of 6,232 firm-year observations during the period 2012-2014. The results revealed a significant negative association between annual report complexity and analysts' coverage.…”