The effect of the CEO's power on the narrative disclosure of financial reports with an emphasis on the role of earnings management and institutional investors

This research aims to investigate the effect of the CEO's power on the narrative disclosure of financial reports with an emphasis on the role of earnings management and institutional investors . beyond financial statement numbers, narrative disclosure is a pervasive feature in the management reporting environment and is considered a rich repository of value-related information that can be used to enhance decision-making by investors, lenders, and other capital providers. Such narratives can provide a useful environment for understanding the process of generating numerical financial data and provide a promising method for measuring the quality of financial reporting and disclosure characteristics of companies. Recent studies have shown that the readability of financial reports is affected by the power of managers. On the one hand, powerful CEOs can through the channel of improving company performance, the motivation to maintain reputation and reputation, the creating a strong personal and professional network for better access to important information (even private information) and valuable actions such as superior management practices and social responsibility activities have a positive effect on the readability of financial reports. On the other hand, economic theories consider the CEO's power as an agency problem and state that increasing the CEO's power aggravates agency problems by increasing managerial positions and causes imbalance and changes in the interests of managers and shareholders. This view believes that the CEO's power increases management's ability to achieve personal benefits (at the cost of ignoring shareholders' rights) and has a negative relationship with company performance. Therefore, it is not unexpected to predict a positive relationship between CEO power and the difficulty of reading financial reports, which results from the negative consequences of powerful CEOs, including a higher level of opportunistic behavior and poor firm performance. According to the ambiguous management hypothesis, managers' motivation can obscure and hide information through disclosures with less transparency. Managers can hide information that they do not want to disclose and make it difficult for investors to understand financial reporting. In this regard, research has shown that the annual reports of companies with poor performance are harder and longer to read. This is because managers are concerned about raising capital and its impact on the market due to their poor performance, and therefore, they may deliberately decide to make financial reports more illegible to obscure and complicate their poor performance. Therefore, the relationship between CEO power and the difficulty of reading financial reports is expected to be moderated by poor firm performance. In addition, researches have shown that effective corporate governance can reduce the opportunistic behavior of managers. Corporate governance practices can have a significant impact on the company's strategic decisions, such as decisions about information transparency. Corporate governance is a set of mechanisms that cause managers to make decisions in order to maximize the value of the company for the owners. The implementation of the corporate governance system can lead to the optimal allocation of resources and the promotion of the transparency of the information published by the company, and ultimately economic growth and development. Strong corporate governance provides timely and quality reporting disclosure by companies. Therefore, the incentives of powerful CEOs to manipulate the readability of corporate reports are expected to be largely limited by strong corporate governance mechanisms. Based on the above discussions, the main purpose of this research is to investigate the relationship between the CEO's power and the narrative disclosure of financial reports, emphasizing the role of earnings management and institutional investors.



Methods: In order to achieve the goal of the research, the principal component analysis method was used to measure the power of the CEO, and the readability criterion of the financial reports was used to the narrative disclosure of financial reports. Research hypotheses were tested for 105 companies admitted to the Tehran Stock Exchange between 2015 and 2021.



Results: The results show that the power of the CEO has a positive and significant effect on the readability of financial reporting. Also, earnings management has a negative and significant effect on the relationship between the power of the CEO and the readability of financial reporting. Finally, the results showed that institutional investors have a positive and significant effect on the relationship between the power of the CEO and the readability of financial reporting.



Conclusion: As the power of the CEO increases, the level of readability of financial reporting increases. However, powerful CEOs, when their companies are performing poorly, publish more complex financial reports with less readability in order to hide their opportunistic behavior and reduce the possibility of its identification by investors, financial analysts and other legal entities, which is in accordance with the hypothesis of ambiguous management. Also, institutional shareholders can supervise the management of the company with sufficient knowledge and experience in related financial and specialized fields. The supervision of institutional owners will prevent managers from presenting financial reports with low readability, which is in line with the hypothesis of active supervision.