The Effect of the CEO's Power on the Readability of Financial Reports with an Emphasis on the Role of Earnings Management and Institutional Investors

Document Type : Research Paper

Authors

1 Department of Accounting, Faculty of Commerce and Business, University of Tehran, Tehran, Iran.

2 Department of Accounting, Higher Labor Education Institute, Qazvin, Iran.

3 Department of Accounting, Faculty of Business and Economics, Persian Gulf University, Bushehr, Iran.

10.22103/jak.2024.22274.3953

Abstract

Objective: Beyond financial statement numbers, narrative disclosure is a ubiquitous feature in the management reporting environment and is considered a rich repository of value-related information that could be harnessed to enhance decision-making by investors, creditors, and other capital providers. Such narratives can provide a useful setting for understanding the generation process of numerical financial data and they offer a promising way to gauge firms’ financial reporting quality and the characteristics of corporate disclosures. Recent studies have shown that the readability of financial reports is affected by the power of managers. On the one hand, powerful CEOs have a positive effect on the readability of financial reports via 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 critical information (even private information) and valuable practices such as superior management practices and social responsibility activities. 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 causing 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 they do not want to disclose, making it difficult for investors to understand financial reporting. 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 poor performance. Therefore, they may deliberately make financial reports more illegible to obscure and complicate their poor performance. Therefore, poor firm performance is expected to moderate the relationship between CEO power and the difficulty of reading financial reports. In addition, researchers 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 to maximize the company's value 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, as well as, 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 primary purpose of this research is to investigate the relationship between the CEO's power and the readability of financial reports, emphasizing the role of earnings management and institutional investors.
 Method: To achieve the research goal, the principal component analysis method was used to measure the CEO's power, and the Fog index was used to measure the readability of financial reports. The research hypotheses, made using 105 companies listed on the Tehran Stock Exchange in seven years from 2015 to 2021, were statistically tested based on a multiple regression model.
 Results: The results show that the CEO's power 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 CEO's power and the readability of financial reporting. Finally, the results showed that institutional investors have a positive and significant effect on the relationship between the CEO's power and the readability of financial reporting.
 Conclusion: As the CEO's power increases, the readability level of financial reporting increases. However, powerful CEOs publish more complex financial reports with less readability to hide their opportunistic behavior and reduce the possibility of its identification by investors, financial analysts and other legal entities when their companies are performing poorly, which is in accordance with the hypothesis of ambiguous management. Also, institutional shareholders can supervise the company's management 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 aligns with the hypothesis of active supervision.

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  • Receive Date: 30 September 2023
  • Revise Date: 06 January 2024
  • Accept Date: 07 January 2024

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